Dollar Doom Loop and Pakistan

OPINION

Ammar H. Khan

Dollar Doom Loop on importing energy and food in key US$ terms, resulting in both energy and food inflation in local currencies. This and Pakistan triggered monetary tightening across all non-energy exporting markets, as economies scampered to avoid any major depreciation that could push them into an inflationary spiral. Similarly, many emerging markets have issued US$ The era of cheap money is over. The global financial crisis of 2008 led to an explosive growth in money supply with close-to-zero interest rates in US$ and other major currencies, triggering a demand for increasingly risky assets. Further increase in money supply post pandemic further flushed the world based sovereign debt. As interest rates remained close-to-zero for more than a decade, many sovereigns were able to borrow at considerably low rates to fund consumption, and their trade deficits. As the interest rates increase in US$ terms, and the value of US$ increases in local currency terms, there will be a double whammy effect. Sovereigns that would not be able to service higher interest expense, resulting in increasing deficits, with excess liquidity, resulting in too much money chasing too few and eventually spending cuts on social and welfare front, goods. When such a scenario materialises, that results in inflation, resulting in a high human cost. Sri Lanka, Zambia, and Ghana as prices of goods and services are bid up given excess availability are some examples of sovereigns that are looking to restrucof liquidity. ture, or reprofile their sovereign debt. More countries may The monetary phenomenon driving demand pull inflation emerge as the cost of servicing the debt increases resulting in was further compounded by supply constraints during the last adverse developmental effects.eighteen months. Initially due to disruptions in the supply chain In view of a dollar doom loop rolling out globally, the due to the pandemic, and then due to the Russian invasion of most obscene policy a sovereign can adopt is trying to go Ukraine which sent shockwaves through the energy markets, against the flow and maintain an overvalued currency, particeventually resulting in cost push inflation. ularly when it doesn’t have any foreign exchange reserves to To rein in inflation, the US Federal Reserves has adopted a maintain an overvalued currency. Such a sovereign is Pakistan, hawkish stance and has been increasing interest rates. As interest which through political machinations is trying to maintain rates for US$ started increasing, there was an accelerated shift an overvalued currency despite suffering through a balance away from risky assets towards the US$, signifying a flight to of payments crisis, as well as a natural disaster which has quality. The US$ has appreciated by more than 15% against major displaced more than 30 million people.currencies since the beginning of 2022. The US Federal Reserves The sheer disregard to ensure sustainable economic continues to maintain a hawkish stance to bring inflation back growth, and to ensure ability to wade through a potential within its target range. global recessions over the next few quarters is appalling. The As the US$ increased in value against all major developed short-term goal of maintaining an overvalued PKR would and emerging currencies, US$ driven inflation fed into inflationary result in a heavy price that the country and its inhabitants cycles across emerging markets, as they remain largely dependent would have to pay in the times to come. Restructuring of debt may provide some cushion, but if the opportunity is wasted by subsidising luxury consumption, and not for building back better following floods – the macroeconomic scenario would even be much worse. The writer is an independent macroeconomist and energy analyst. The dollar doom loop is in motion. We can either prepare for the same through policy measures that conserve foreign exchange reserves and bolster export proceeds through a competitive currency, or we can pretend that the world isn’t inching towards a recession, and that someone somewhere will bail us out. We have had bailouts every few years now. The music has stopped. The punch bowl has been removed. Meanwhile, we continue to pretend that the party continues, much to our own detriment.