U.S. dollar at levels ‘we haven’t seen in 20 years,’ Harvard professor says

Harvard University Professor of Capital Formation and Growth Jeffrey Frankel joins Yahoo Finance Live to discuss the strength of the U.S. dollar, the impacts from foreign exchange rates and currency volatility, and the outlook for the U.S. economy as recession risks mount.

Video transcript

- Well, the surging dollar has created a host of problems for central banks, governments, and businesses the world over, despite the benefits for US-based importers and American travelers. The strength of the world's reserve currency is adding extra pressure to already troubled major economies, like the UK and Japan, not to mention the broader developing world. In a recent op-ed, Jeffrey Frankel says the US economy's relative strength and Fed tightening will keep the greenback strong for some time.

He's Harvard University professor of capital formation and growth, and he joins us now. Professor, it's good to talk to you. We gave away your thesis right there, but walk me through your thinking right now, as we see the dollar continue to surge. We're looking at levels we haven't seen in 20 years.

JEFFREY FRANKEL: Yes, that's right. First, good to be-- good to be with you. Levels we haven't seen in 20 years and, by many measures, that we haven't seen since 1985, which is almost 40 years, against major-- major currencies. There's talk about is this a bubble, does it require government intervention, cooperation, a new Plaza Accord? The Plaza Accord is what the G5 countries agreed in 1985 to bring the dollar down. But I think the strength of the dollar can be readily explained by economic fundamentals.

- Economic fundamentals being that the US continues to be, despite concerns around inflation here, in a relatively better position in terms of the economy compared to its peers? Is that-- I mean, is that really what it comes down to in terms of why people are putting their money behind the dollar?

JEFFREY FRANKEL: That is what it comes down to. The exchange rate is us versus them, of course, relative. But I would break it down into three factors. First, economic strength. Despite all the talk about recession, the US economy remains pretty strong, certainly by measures such as employment, and even gross domestic income and so on. And meanwhile, Europe is hit by the shock of losing Russian natural gas, and some of Europe generally is in trouble. Japan is stagnant. The economy has not even retained its GDP where it was before the-- before 2020. China is facing a big slowdown.

So relative growth rates is factor number one. Factor number two is commodity prices. Prices of oil, other forms of energy, minerals, agricultural products, of course, have gone up over the last couple of years. But our trading partners are much more vulnerable to that. We're no longer a net importer of oil or other forms of energy. We're a net exporter. And same for agricultural products. So whereas Europe and Japan and China are importers. So they've been badly hit by the increase in prices of oil and other forms of energy.

And number three, probably most important, the Federal Reserve has-- is ahead of the others, or is raising interest rates faster than the others in order to fight inflation. And when a country has higher interest rates, that attracts some international investors and it causes the currency to appreciate.

- So all those factors certainly put the US in a better position. With that said, we have heard so many companies warn about FX headwinds because of the strength of the dollar in its most recent quarter. And I wonder, when you think about the risk factors at play here, to what extent is this likely to potentially tip into a earnings recession, when you think about companies having to deal with these headwinds that are already weighing on their balance sheets?

JEFFREY FRANKEL: Well, of course any movement in the exchange rate has pros and cons. The con is loss of international competitiveness, loss of exports, which hasn't happened yet, but may start to happen, an increase in imports, hurting import competing industries. But that's really just a side effect of the Fed tightening. Higher interest rates hurt the construction sector, housing sector, and other interest rate sensitive sectors, and the higher dollar hurts internationally-- those sectors open to international trade. But what the Fed is doing, has to do, is try to slow down the economy in order to get our inflation rate back down.

- Really quickly, Professor, we've already seen the Bank of Japan intervene to prop up the yen. Are we likely to see more central banks take similar moves, given where this is all headed?

JEFFREY FRANKEL: Well, it's hard to say. I kind of doubt it, but I wouldn't have predicted probably the Bank of Japan because-- intervening. They haven't done it for 11 years, and the G7 countries had agreed not to intervene in foreign exchange markets some years back. So this is sort of unusual, a return to the interventions of the '80s and '90s. The US doesn't regard the current situation as a problem, so I don't think we join any intervention. And without the cooperation of the Federal Reserve, other countries intervening on their own, they're generally not effective.

- Jeffrey Frankel, Harvard University professor of capital formation and growth, good to have you on the show today. Appreciate the time.