The US is in the grip of its worst bout of elevated inflation and at 9.1 percent in June, the pace outstripped that of many emerging-market economies, including India.
High inflation has traditionally been thought to be a problem of emerging markets, given the strong underlying demand that’s characteristic of a growing economy.
After two shocks, the COVID-19 pandemic followed by the Russia-Ukraine war, inflation as a phenomenon has entered uncharted territory. Supply shortages, unmet demand and too much money chasing too few goods are now an advanced-economy problem as well.
The outcome of elevated inflation is erosion in the value of an economy’s exchange rate. If a country’s inflation is higher relative to its trading partners', its currency has to adjust down. Then what explains the US dollar’s supremacy at all times?
Be it the inflation trade, wherein the bets are for an elevated cost of borrowing, or the recession trade, wherein investors bet on interest rates coming down due to economic contraction, the dollar wins on both arguments.
At the heart of this is the belief that any adverse developments in the US economy would hurt other countries more than the US itself.
The Inflation Trade
Too much money chasing too few goods results in inflation. The US Federal Reserve’s responses to a crisis result in a glut of dollars as it loosens its monetary policy.
It is then no surprise that the crisis responses of the Fed that floods the market with dollars eventually drives up the prices of everything in the US economy. Inflation has followed the Fed’s period of loose monetary policy every time. Recall that former Fed chief Alan Greenspan’s generous policies handed his successor Ben Bernanke a tough inflation challenge.
But none of the previous inflationary bouts in the US has matched the current one in intensity. The difference between inflation this time and in the past has been a geopolitical shock and the pandemic.
Russia’s war on Ukraine affected the supply of crude oil given that the former is one of the top exporters of petroleum products and gas. The war came on the back of supply chain disruptions caused by COVID-19 which had already driven up prices of most commodities globally. Global inflation has surged and almost every country is facing a sharp rise in prices.
Read More at https://www.moneycontrol.com/news/business/markets/us-inflation-outpaces-indias-so-why-is-the-dollar-still-strong-8829021.html
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