By Geoffrey Smith 

-- Can anything stop the almighty dollar?

The greenback has been on a tear this year as the Federal Reserve has embarked on the longest and most aggressive tightening of U.S. monetary policy in 30 years. It’s up 17% against a basket of advanced economy countries, and by much more against some important emerging ones. By contrast, U.S. equity indices are down by as much as 31%, while even gold – supposedly a safe haven – is down nearly 10%. The , which tracks the buck against half a dozen of its rich-country peers, stands at a 20-year high.

Traditionally, that has tended to spell bad news for the world economy. Indeed, the Bank for International Settlements – the so-called central bank of central banks – has argued that the dollar has replaced the famous as the world’s real "fear gauge" and is a much more accurate reflection of global risk aversion.

There is undoubtedly much to fear. First, there is war in Europe, which has brought the use of nuclear weapons closer than at any time since 1962. Even if it continues on its current trajectory, the war is wrecking the global market for energy and other commodities. It is, as Credit Suisse’s global funding markets guru Zoltan Poszar wrote earlier this year, inherently inflationary.

The war is also hastening the end of the age of globalization, which allowed energy and goods to flow relatively freely and cheaply around the world. Europe has cut its links with Russia, its cheapest energy supplier; the U.S. is in the middle of cutting links with China, its cheapest supplier of consumer goods. And almost all of the developed world is deliberately reducing the supply of cheap labor in response to popular discontent at immigration. Donald Trump and – since last Friday – the U.K.’s Brexiteers may no longer be in the ascendant but, in the last two months alone in Europe, Sweden and Italy have elected right-wing governments with broad populist streaks.

“What oil is to an industrial economy, people are to a service economy,” Poszar argued, in a note last month, and the U.S. labor market, to judge by September’s labor market report, is having its “OPEC Moment.”

All that points in the direction of higher embedded costs in the years to come. Higher embedded costs mean higher inflation and a Federal Reserve that cannot afford to take its foot off the brakes, at least not while is still near a record low.

Right now, interest rate futures point to a peak in Fed rates around 5% in the first quarter of next year, equivalent to another 175 basis points of tightening. But without an end to the war, some see even more than that.

“Make no mistake about it: the risk of the Fed hiking to 5% or 6% is very real, and ditto the risk of rates cresting there despite economic and asset price pain,” Poszar wrote in a recent note.

And that, of course, is terrible news for the global economy, especially for countries that have borrowed dollars freely during the last 13 years of loose U.S. monetary policy. Just since the start of the pandemic, dollar borrowing by non-U.S. entities has risen by over $1.2 trillion, according to BIS figures. Assuming Fed rates hit 5%, the annual cost of servicing that debt will be $57 billion higher than it would have been at the start of this year, draining badly needed capital from the world’s poorer countries. 

The International Monetary Fund cut its global growth forecast last week to below 3% for the first time since 2000. With higher interest rates causing recessions around the world, the Fund even sees a 25% chance of global growth sinking below 2% in 2023. If that comes true, then plenty more countries will see the kind of violence that has plagued Sri Lanka, Peru and others this year.

"The worst is yet to come, and for many people 2023 will feel like a recession,” the IMF said in its World Economic Outlook.

In other words, while King Dollar usually acts as an enlightened monarch, enabling trade and investment around a world that likes to deal with a single unit of account, for the foreseeable future he will seem more like the erratic despot that the world’s anti-American leaders have often claimed him to be.