On Friday, the dollar marked another day of appreciation against the lei after the American currency crossed the threshold of 5 lei on Thursday. Since the beginning of the year, the dollar has increased by about 15% against the lei, while the euro has hovered around 4.94 lei.

First, why is the dollar getting more expensive?

The dollar is becoming more expensive due to the high demand for dollars, writes Banca Monfială in its blog. The economic outlook for most economies points to a significant slowdown, and the eurozone is poised to enter recession. In addition, the war in Ukraine has caused enormous geopolitical risk and high volatility in financial markets.

In addition, high inflation in America forced the Fed (US central bank system) to aggressively raise interest rates, making the US currency more expensive.

All of this is forcing investors to flee to safety, leave European markets and choose American assets, which obviously require dollars to buy.

It should be noted that markets continue to bet on an increase in the Fed’s interest rate.

The first effect is related to concerns about foreign debt denominated in dollars

Based on this, expect more tension in the area of ​​sovereign debt – and not only in Romania.

In our country, according to the financial report, about 8% of the debt portfolio is denominated in US dollars, “and the volatility of the lei/dollar exchange rate in recent years has been about three times higher than the lei/euro exchange rate. Thus, debt denominated in US dollars represents a much higher degree of risk than debt denominated in euros.”

Many countries, especially the poorest, cannot borrow in their own currency in the amount or for the term they want. Lenders do not want to take the risk of repaying the debt in the unstable currencies of these countries.

These countries usually borrow in dollars, promising to repay their debts also in dollars – regardless of the exchange rate. Thus, as the dollar becomes stronger against other currencies, these debt payments become much more expensive in domestic currency. This is what – in the language of public debt – is called “original sin”.

The NBR is also obliged to raise interest rates, but to what extent?

As the US Federal Reserve raises interest rates, other central banks must raise their own rates to remain competitive and protect their currency. In other words, investors need to be given good reasons (such as higher returns) to keep their money in a developing economy rather than move it to less risky assets such as the US.

But if it raises interest rates, it slows or suppresses economic growth and increases unemployment, which no central bank in the world wants. In addition, the slowdown of the economy will also affect budget revenues, which will complicate the situation and further complicate the debt problems.

Another effect is related to trade

In the short term, a strong dollar could also weigh on trade. The dollar dominates international transactions. Oil transactions are carried out in dollars, for example.

As the dollar strengthens, imports (expressed in lei) become more expensive, forcing firms to cut back on investment or spend more on key imports.

For Americans, an appreciation of the dollar contributes to inflation (by lowering the prices of imported goods), while it embarrasses Iserescu (by increasing the prices of imported goods).

A study by the Federal Reserve Bank of Cleveland found that a 1% appreciation in the dollar typically reduces import prices by a cumulative 0.3% over six months. This decline is partly reflected in lower inflation. So the Treasury Department and the Fed are very happy about the appreciation of the American currency.

The pressure on the ECB to increase the euro more aggressively is increasing

However, a stronger dollar is putting pressure on the European Central Bank to raise its own interest rates to support the euro and lower the cost of imports, including energy. This will increase the pressure on highly indebted eurozone countries. Italy, which is the world’s ninth largest economy and has a public debt of 150% of GDP, will be particularly difficult to bail out if the situation gets out of control.

Will the dollar continue to grow?

Therefore, the dollar rate increased for both economic and geopolitical reasons. Persistent inflation will force the Fed to continue raising interest rates in the US, which will keep the dollar strong.

In Romania, major commercial banks confirmed to HotNews that year-end estimates are aimed at weakening the lei against the euro.

A strong dollar: advantages and disadvantages

The dollar is considered strong when it rises in value against other currencies. A stronger US dollar means it can buy more currency than before. For example, a strong dollar benefits Americans visiting Romania, but hurts Romanian tourists visiting the US.

Thanks to a stronger dollar over the past year, American consumers have benefited from cheaper imports and less expensive travel abroad.

At the same time, US companies that export or rely on global markets for the bulk of their sales have been adversely affected.

Goods produced abroad and imported into the United States will be cheaper if the producer’s currency falls against the dollar. European luxury cars such as Audi, Mercedes, BMW, Porsche and Ferrari will be available at a lower price. If a European luxury car is worth €70,000 at an exchange rate of $1.35 to the euro, it will cost $94,500. The same car (€70,000) sold at 1:1 EUR/USD would only be worth $70,000.

Sources used: World Bank Blog, The Conversation, Investopedia