A Risky Gambit: How Raising Interest Rates is Unintentionally Reshaping the Geopolitical Landscape

In an ever-evolving world, the intricate connection between economics and geopolitics has persisted throughout history. The US has secured its global dominance through the US Dollar, the world’s foremost reserve currency. By raising interest rates over the past year, the US seeks to control inflation, which ultimately fortifies its currency. This move however has potential ramifications for both the global economy and its own, as it could potentially affect businesses and constrict the money supply. I will succinctly examine the major events surrounding the US dollar, including rising interest rates, their consequences on the global economy, and the resulting geopolitical ripple effects.

Disclaimer: The write-up below is based on recent developments and my interpretation of their potential implications. As such, it should be regarded as an informed opinion piece.

The Dollar Strikes Back: Why the US Is Raising Interest Rates

The decision by the US Federal Reserve to raise interest rates is primarily driven by the necessity to restrain inflation, which has been significantly exacerbated by the widespread implementation of quantitative easing — the practice of ‘money printing’ — following the global financial crisis in 2008, and further intensified amidst the COVID-19 pandemic. As the global economy begins to recover, controlling inflation has become a top priority to ensure long-term economic stability. Raising interest rates serves as a tool to combat inflation and reduce the risk of overheating the economy.

Higher interest rates effectively strengthen the dollar, as they make the currency more appealing and costly to investors, resulting in its appreciation. The stronger dollar not only reinforces its status as the world’s dominant reserve currency but also provides the US with more leverage in various aspects of international relations. This increased influence benefits the US in trade negotiations, debt financing, and geopolitical affairs, enabling the country to assert its influence more effectively on the global stage.

Ripple Effects: The Impact on the Global Economy and Emerging Markets

A stronger dollar has far-reaching consequences for the global economy, particularly for emerging markets dependent on foreign investment and dollar-denominated debt. As the dollar appreciates, it becomes more expensive for these countries to service their debt and attract investors, potentially leading to currency crises.

For example, during the 1997 Asian financial crisis, countries like Thailand and South Korea, burdened with high levels of foreign-denominated debt, faced severe economic turmoil. A similar fate could befall countries like Argentina and Turkey, which currently have high levels of foreign sovereign debt. The economic turmoil in these countries could spill over to other emerging markets and eventually to the developed world, causing global financial instability.

Moreover, the US economy is not immune to the effects of its own policy. While a stronger dollar may bolster the country’s trade position, it also has the potential to slow domestic economic growth and increase the burden of its own public debt.

Geopolitical Implications and China’s Big Opportunity

The strengthening of the dollar has sent ripples throughout the global economy, resulting in unavoidable geopolitical realignments. Historically, nations allied with the US, mainly due to their reliance on the reserve currency, are now reevaluating their traditional business practices. This shift has been further magnified by events such as the weaponization of the dollar — a strategy used to apply economic pressure on Russia during their recent conflict with Ukraine. As the world’s primary reserve currency and a key component of international trade and finance, the US dollar’s power was employed to restrict access to dollar-based assets and freeze Russian foreign currency reserves, which represented nearly 35% of Russia’s GDP in 2022.

Many countries, uninvolved in the conflict, perceived their exposure to the dollar as a substantial threat, which leaves them vulnerable to economic and political risks should the US deploy similar tactics and weaponize the dollar against them. This series of events presents a distinct opportunity for China — today’s strongest contender for global leadership, challenging the long-standing dominance of the United States — to position itself as an alternative global player by offering financial assistance and investment to countries in need, potentially gaining the allegiance of nations that might have otherwise turned to the US for support.

This tussle for dominance has been witnessed in the past between the US and other global powers. Most notably, during the Cold War, the US and the Soviet Union competed for influence in countries such as Vietnam, Cuba, Afghanistan, and various African and Latin American nations. This contest for global sway led to several proxy wars and confrontations. The current scenario, with the US utilizing interest rates to fortify the dollar, could signal the beginning of a new era of great power competition. As China capitalizes on the opportunity to expand its global reach, the rivalry between these two superpowers is expected to intensify, yielding unpredictable consequences for the international community.

Conclusion: The Strengthened Dollar — A Risky Gambit

While the US may have found a new way to exert influence on the global stage, strengthening the dollar through interest rate hikes is not without risks. The potential for economic turmoil and geopolitical unrest is significant, as countries grapple with the fallout of rising interest rates and a stronger dollar. The US must be wary of the ‘tipping point’ at which interest rates will shock the entire world and drive most markets into recession. In the face of these challenges, striking the right balance between leveraging the strengthened dollar and managing its potential consequences will be crucial for maintaining global economic stability and fostering international cooperation.

As the US navigates this delicate path, it must also be prepared to engage in dialogue and collaboration with other major economic powers, including China. Cooperation and multilateral approaches will be essential in addressing global challenges and avoiding escalating tensions that could lead to conflicts. Ultimately, the US must carefully weigh its strategic objectives and the potential ramifications of its policies, as it seeks to balance its role as a global leader with the need for international harmony and shared prosperity.