Later in July, US interest rates are expected to jump for the second time this year, and it will ruin any chance of a global recovery.
The Federal Reserve can push up the base rate by as much as a full percentage point, ending 15 years with ultra-cheap money, meant to promote growth.
This jump, to an area of 2.5% -2.75%, will cause the cost of borrowing money in the US to more than double the Bank of England̵[ads1]7;s 1.25%. And yet the Fed can only take a breather as it considers even higher interest rates.
However, this column is not about the United States. It is concerned about the dire impact on the UK and countries around the world of the selfish ignorance of the United States when they decide to tackle high inflation with higher borrowing costs. Britain is already feeling the effects of the Fed’s promise to tackle inflation until it is “defeated”, whatever happens.
Higher interest rates in the US make it a more attractive place for investors to save their money. To take full advantage of it, investors have to sell their own currency and buy dollars, which causes the price of dollars to shoot higher.
In July, the US dollar rose in value against a basket of six major currencies to its highest in 20 years. The euro has fallen below par with the dollar in recent days. The pound, which has plunged more than 10% this year to below $ 1.20, is losing value with each passing week.
In Japan, the central bank has come under enormous pressure to act after the yen fell to its lowest level against the dollar since 1998.
There are two important consequences for those of us who live and work outside the United States.
The first is that goods and commodities priced in dollars are much more expensive. And most commodities are priced in dollars, including oil.
Borrowing in dollars is also becoming more expensive. And while borrowing from a US bank is beyond the average British household, companies are doing so all the time, and especially those in emerging economies, where backyard funds may be in short supply.
Bank of England interest rate setter Catherine Mann recently said her main motivation for seeking significant increases in UK lending rates was her fear that the widening gap with the dollar would push up import prices. And higher import prices meant higher inflation.
If she could only convince her colleagues in the bank’s monetary policy committee that the devaluation of the pound was a serious problem, they might push up the bank’s base rate in line with the Fed’s rate hikes. After the Fed makes its move, more people can join her.
Until January this year, the UK’s inflation rise was about to be short-lived. It now appears that the Russian invasion of Ukraine and a host of untargeted distributions from the Biden administration during the pandemic, which has helped push up prices in America, will keep inflation in the UK high into next year.
The governments that have borrowed in dollars are facing a double shock. Not only will they have to raise domestic interest rates to limit the impact of import price increases, they will also face a massive jump in interest rate payments on dollar loans.
Emerging markets and many developing countries will be destroyed when these extra costs are combined with the loss of tourism from the Covid pandemic. Sri Lanka has already gone bankrupt, and many more can follow.
For the past three decades, Western banks have marketed low-cost loans throughout developing countries as a path to economic freedom.
The Zambian government borrowed heavily before the pandemic to become self-sufficient in electricity. It is a commendable target, but has left the Central African state with a ratio of debt to national income (GDP) about the same as France’s – about 110%.
The problem for Zambia is not the same as for France, which pays an interest rate of 1.8% to finance its debt, measured by the yield on its 10-year bonds. The Zambian 10-year bond has an interest rate of 27%. Now Zambia, like France and so many other countries, has to borrow just to live. To invest is to borrow more.
There is no sign that the United States will change course. Joe Biden is panicking about the midterm elections, as fears of rising inflation may favor Republicans. This panic has spread to the Fed, which has used hysterical language to convince consumers and businesses that higher prices are on the way and to curb their spending accordingly.
The Fed knows that inflation is a problem caused by insufficient supply that only governments can handle. But that does not seem to stop it from pushing the US economy, and everyone else’s, into recession.