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2016-12-20 14:15:43
The strong dollar can mean trouble for emerging markets
Dec 17th 2016
IN SEPTEMBER 2010 Brazil s then-finance minister, Guido Mantega, gave warning
that an international currency war had broken out. His beef was that in
places where it was difficult to drum up domestic spending, the authorities had
instead sought to weaken their currencies to make their exports cheaper and
imports dearer. The dollar had recently fallen, for instance, because the
Federal Reserve was expected to begin a second round of quantitative easing.
The losers in this battle were those emerging markets, like Brazil, whose
currencies had soared. Its currency, the real, was then trading at around 1.7
to the dollar.
These days a dollar buys 3.4 reais, but no one in Brazil or in other emerging
markets with devalued currencies is declaring a belated victory. A cheap
currency has not proved to be much of a boon. Indeed new research from Jonathan
Kearns and Nikhil Patel, of the Bank for International Settlements (BIS), a
forum for central banks, finds that at times a rising currency can be a
stimulant and a falling currency a depressant. They looked at a sample of 44
economies, half of them emerging markets, to gauge the effect of changes in the
exchange rate on exports and imports (the trade channel) and also on the price
and availability of credit (the financial channel).
They found a negative relationship between changes in GDP and currency shifts
via the trade channel. In other words, net trade adds to economic growth when
the currency weakens and detracts from growth when it strengthens, as the
textbooks would have it. But they also found an offsetting effect of currencies
on financial conditions. For rich countries, the trade-channel effect is bigger
than the financial-channel effect. But for 13 of the 22 emerging markets in the
study, the financial effect dominates: a stronger exchange rate on balance
speeds up the economy and a weaker one slows it down.
This attests to the growing influence of a global financial cycle that
responds to shifts in investors appetite for risk. Prices of risky assets,
such as shares or emerging-market bonds, tend to move in lockstep with the
weight of global capital flows from rich to poor countries. These flows in turn
respond to changes in the monetary policy of rich-country central banks,
notably the Federal Reserve, which influences the scale of borrowing in dollars
by governments and businesses outside America. Global financial conditions are
thus responsive to attitudes to risk. When the Fed lowers its interest rate, it
not only makes it cheaper to borrow in dollars but also drives up asset prices
worldwide, boosting the value of collateral and making it easier to raise
capital in all its forms. A few days before Mr Mantega declared a currency war,
Brazil s government was celebrating a bumper $67bn sale of shares in Petrobras,
its state-backed oil company, for instance.
The BIS researchers find the financial channel works mainly through investment,
which relies more on foreign-currency borrowing than does consumer spending.
Their results are sobering for emerging-market economies. They suggest that a
cheap currency cannot be relied on to give a boost to a sagging economy. More
worrying still, the exchange rate might not always act as a shock absorber;
rather it may, through the financial channel, work to amplify booms and busts.