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Strong dollar has implications

Far-reaching effects may include trimming of global economy by $2.37 trillion

Dubai — Heralding far-reaching implications across world markets, principally for commodity prices, the nominal global economy is going to be about $2.37 trillion smaller in 2015 than what was forecast earlier due to the strengthening of the dollar on the back of a strong US economy, economists said. 

“This is an unusual event. It will be the sixth time since 1980 that global nominal GDP contracts in dollar terms and the second biggest contraction since 2009,” economists at Bank of America Merrill Lynch, or BofAML, said in the latest Global Economic Weekly.

This contraction in nominal global GDP in 2015 to $68.61 trillion is not insignificant, as it represents 3.2 per cent of the estimated $70.9 trillion for 2014. “For perspective, that would be as if an economy of the size between Brazil’s and the UK’s would have just disappeared,” they said.

Nominal world GDP is the value of production across the globe at current market prices measured in dollar, while real GDP is the value of production using a given base year prices.

In fact, in real terms, global real growth is expected to accelerate to 3.5 per cent in 2015 from 3.3 per cent in 2014. The reason is that the volume of goods and services produced will increase at a faster rate. However, it is just that most of them are going to be produced in countries where the currency has weakened against the dollar and will continue to weaken.

According to BofAML forecasts, the US is the only country and emerging Asia the only region where nominal GDP in dollar terms will expand this year. 

Global nominal GDP has contracted in only five years since 1981, and in three of those years by less than one per cent. It has taken major events such as the 1982 debt crisis (-2.3 per cent) and the 2008-09 Great Recession (-4.6 per cent) to bring nominal global GDP contractions of the size likely in 2015.

In normal times, nominal global GDP expands significantly every year. Average nominal global GDP growth has been six per cent since 1981. 

“The recent oil price plunge has brought significant debate about whether it was sparked due to changes in supply or due to lackluster global demand. Although both sides of the story have merits, we are forecasting real global growth to accelerate this year. In addition, most other commodity prices, including iron ore, copper and sugar, have dropped significantly in recent months.”

Accompanying the plunge in oil prices has been a sharp appreciation in the US dollar, strengthening 12 per cent on a trade-weighted basis since the end of June. After adjusting for inflation, the real trade-weighted dollar is up nearly 10 per cent over that same period or eight per cent year on year.

“This dramatic move has led many to question whether a stronger dollar will alter the Fed’s timing of lift-off. We are skeptical that the dollar move, in isolation, will be enough to alter the timing of rate hikes. The US economy continues to improve and if some of the external downside risks for inflation abate, the Fed should be able to move toward the exit. We remain comfortable with our baseline forecast for lift-off in September,” they said.

The bank’s economists argued that the cause of the dollar move matters — if the dollar is strong due to a flight to safety, it means it is accompanied by weak capital markets and confidence, but if the dollar is appreciating due to stronger US growth, then it is simply the by-product of better economic fundamentals.

— issacjohn@khaleejtimes.com