Strong Dollar – Why global markets need to be cautious

Global bond guru, Mohammed El Erian, has warned the world markets about the perils of a strong dollar. As the world is coming to believe that a strong dollar could be a big benefit, Erian’s views are of tremendous value. Here are the 3 reasons why Mohammed El Erian is extremely wary of a strong US Dollar…

What it means for US equities… 

Contrary to what many would like to believe, a strong dollar is not always favorable for US equities. Most of the top US companies derive a chunk of their revenues and profits operating out of other countries, especially emerging markets. Now, just as a weak currency benefits exports and foreign operations, a strong currency is negative for exports and foreign operations. Take the case of Cisco which sells routers in Turkey. Now Cisco operations in Turkey will earn in Turkish Lira. But since the dollar is getting stronger, each Turkish Lira earned by Cisco will effectively earn lesser dollars when the money is brought back to the US. This is one of the reasons many technology driven companies in the US have been showing tepid growth. A stronger dollar works against their non-dollar earnings. Weak global earnings are not great news for the US which is increasingly depending on growth in demand from emerging economies to boost its sales and revenues. Very soon, this will translate into value destruction in equities as well as the market cap of the Dow Index.

Probably, a currency war… 

There is a certain ominous tinge to the term, “Currency War”. But that is what it could eventually boil down to. As the dollar gets stronger, China will be forced to devalue the Yuan. That will trigger off a domino effect across EMs as China is already the largest trading partner for most of the EMs. As the Yuan gets weaker, other EMs will be forced to cut the value of their currencies. A currency war is also knows as a process of competitive devaluation. Countries compete with each other in making their currency cheaper with the hope of boosting exports. In the event, it only debases the currency and imports inflation from stronger currencies. 

The big dollar debt burden…

Global private debt denominated in US dollars is to the tune of $9 trillion. Any strengthening of the US$ results in substantial losses for these debt issuers in terms of servicing and repayment capacity. In the last year alone the world has added nearly ½ trillion worth of US dollar denominated debt. That will be the big concern for global markets. A sustained strengthening of the dollar will mean that many corporations across emerging markets could suddenly find themselves on the brink of bankruptcy. According to basic estimates, a large chunk of this debt is un-hedged. It is anybody’s guess what the cascading effect could be as dollar strengthens! ©

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