Why is the dollar so strong? It has soared 25 per cent on a real
trade-weighted basis in the past four years, evoking memories of ascents in the
early 1980s and again at the turn of the millennium. In the previous cases, the
result was a widening of trade and current account deficits. What might be the
outcome this time?
The answer to the first question is that the US has far stronger demand,
relative to potential output, than the other big economies — the eurozone,
China and Japan. The answer to the second is that it will impose strong
deflationary pressure and weaken demand for US output, making it harder to
tighten policy than the Federal Reserve imagines.
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