The strength of the dollar in 2022 makes U.S. imports cheaper, but, by the same token, it raises prices for every other country that pays for oil, for instance, in dollars. To respond to this imported inflation, other central banks have little option but to raise interest rates even more, which continues a vicious circle. The end result of this bidding war is unpredictable as far as the exchange rate is concerned, but one thing it will do is drive interest rates to levels higher than anyone would have picked in isolation.
And this is not the only spillover effect we must fear in this first global disinflation. The price of traded goods depends not only on exchange rates but also on the balance of demand and supply, in world markets as well as national markets. During the economic recovery from Covid, inflation in the United States was propelled not only by excess demand at home but also by supply-chain bottlenecks in China.
Now the reverse is happening. As many central banks raise their rates, they are not just disinflating their own economies, they are shifting the balance of demand and supply for everyone else, too. If these spillover effects are not taken into account we must fear that we will end with more disinflation than we need.
How big this effect of global spillover will be, we can only guess. We have estimates of positive inflationary spillovers. As far as global disinflation is concerned, we are in far less charted territory.
And there is one other thing we do not know. Even if we can agree on the right interest rates to disinflate the world economy at minimum cost, can a world economy that has grown used to ultralow interest rates take the strain of positive rates? For a decade or more it has made sense to pile on leverage.
With rising rates, though they remain mostly negative in real terms, some debtors will find themselves in trouble. Pity particularly the companies and countries around the world that have borrowed in dollars, to the tune of more than $22 trillion by 2019, and now face repayments at a steeper exchange rate. Struggling to keep up with debt service, they will most likely first squeeze other spending, compounding the recession, and then seek to restructure their debts. At that point recession will tip into crisis and outright failure of businesses and sovereign borrowers.
Market purists will insist that this was long overdue: It is high time to cull the zombies — borrowers who live on only because the cost of borrowing is so low. But talk of culling is better on paper than in practice.