"Currency Fluctuations And Currency Wars Across Globe" By Mr. Tariq Carrimjee - GADGET-INNOVATIONS

"Currency Fluctuations And Currency Wars Across Globe" By Mr. Tariq Carrimjee

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Meanwhile, Over In The Currency Markets


It would be easy to title this piece Currency Wars but perhaps too easy. Currencies fluctuate minute to minute and are by nature constantly being buffeted by investors, manoeuvred by central banks in pursuit of policy goals, whipped about by speculators and even used by businesses with genuine trade flows. It’s only when active policy interventions by governments (through their agents the central banks) force unsustainable terms of trade against trading partners does the question of currency wars arise.



August is traditionally a particularly volatile month in the FX markets and this year is not likely to be an exception. We’ll take a look at what’s affecting the US Dollar, the Euro, the Indian Rupee and how the Chinese Yuan has been an instrument of economic policy for the Chinese.



The fact that this has been an extraordinary year would be an understatement. Every economy has had to undergo some form of a lockdown and a partial to complete shutting down of their economies in order to cope with the spread of the Covid-19 super virus. The enforced lockdowns have affected production, damaged GDP figures, skewed trade numbers, prompted interest rate cuts, loan deferments and prompted large budgetary support for the now non-productive populace even as tax revenues have plummeted due to lower wages, corporate profits and sundry goods and services tax collections.



These are usually the drivers of relative currency performance as they affect trade, confidence, and thus investment decisions. The US, for example, has always stated that they prefer a stronger Dollar but they have- at the same time, been the first to brand- or threaten to brand, others with the ‘currency manipulator’ tag. That is to say, call out other countries like China for artificially keeping their currencies weak in order to promote their exports. In the past, they used this against Japan but of late China and occasionally India fall foul of the Americans. So, whilst they need to have the appearance of a strong currency being the world’s largest debtor nation, the backers of the dominant trading currency and the currency of choice for maintaining Foreign Exchange reserves, they do not like the effects this produces- namely, trade deficits.



China, India, Japan all maintain healthy USD reserves. A crisis of confidence in the USD could be catastrophic for US finance. This is being tested this year with the massive stimulus infusions the US government is infusing to prop up its shrinking economy. With USD 2.8 trillion already allocated (up to June end) and another stimulus package being negotiated, real interest rates negative all whilst antagonising trading partners like China, it’s unsurprising that the dollar index has fallen so sharply this year (see Graph 1 below).



Some of these aggressive non-market retaliations may damage the US Dollar far more in the longer run than what is visible in just the chart though. There is a risk to the fundamental advantages the US holds by being the dominant currency of trade- all commodities are priced in USD terms, as are 60% of all trade (according to data by the Bank of International Settlements) that can be lost if faith in the US Dollar is lost.

Graph 1: The Dollar index (DXY) in the last 6 months

One country that has managed to successfully hide a successful trade balance without attracting widespread condemnation is Germany, which hides behind the Euro. But Europe as a whole may be setting itself up for problems in the future despite the fact that it has had a ‘good crisis’. That it has managed to get on top of the outbreak and bring down new cases; that all of its members took strong action to ensure that workers didn’t get laid off leading to unemployment barely rising and making it easier to restart the economy with the same workforce has instilled confidence in Europe as a well governed bloc.



Europe’s problem is simple: the scientific no-nonsense response that led to a Eur. 750 billion pandemic recovery fund- the first large scale issuance of European bonds, has instilled so much confidence that the sovereign spreads of the weaker members- Portugal, Italy and Spain, have started falling and the currency started strengthening. The Euro is up 5% over a weighted average over the last few weeks- indeed a just below a 2-year high. The graph below illustrates a contrast with the USD.

Graph 2: The EXY gains from good policy

The problem lies in the openness of the European bloc: fully 30% equivalent of GDP of goods and services are exported out of the bloc. This compares to just 12% of GDP for the US. Even China and Japan are far less exposed. And the last time the Euro was this strong in 2017-18 it led to two years of low growth thereafter.



In the case of Europe, a strong currency may have geopolitical benefits but confer none from a trade perspective. A recent IMF paper by Adler, Gopinath and Buitron on the effect on trade based on ‘dominant currency pricing’ suggests that, where trade is set in a dominant currency- the US Dollar for example (as is mainly the case in Emerging Market economies) depreciations have very limited positive impact.



And, in fact, because imports are also set similarly, higher prices lead to imported inflation and an adverse trade bill. Europe is one of the dominant pricing currencies and- coupled with a strengthening currency in weak global trade markets, an open and exposed market, may suffer in the short run. Given the reliance on tourism for Italy, Spain, France and Portugal the effects may extend the pain of this year’s setbacks.



But these are short term effects. As China has shown- having learned from Japan, and now teaching India, longer term growth can be achieved with a controlled undervaluation of a currency. China engineered a surprise devaluation in 2015 and even now the Yuan is 10%  lower than the pre-devaluation level of 6.2 to the Dollar. And, since 2018 the Yuan has systematically weakened from near those levels. Much of the reason can be ascribed to the ongoing tariff and trade struggles with the US. Until then, the Yuan was on a gradual appreciation path.



The Yuan faces a similar yet dissimilar dilemma as the US. It wants to be in the same position as the US but wants to maintain its export competitiveness. Since it makes up approximately 2% of global FX reserves compared to 62% for the US Dollar (and 20% for the Euro) it can attract a lot of more global investments- which would make the currency a lot stronger. At this point, however, the Chinese seem content to let that ambition stay by the wayside as they ride out the trade battle with the US and let their currency depreciate slowly.



If China wants to be like the US then India wants to be like China. They have engineered a devaluation against the US Dollar this year marking them as one of the worst EM currency performers. Yet, in this short period India has upped its foreign exchange reserves from around USD 480 billion to just under USD 540 billion. This gives comfort to overseas investors and may be key to ensuring that India doesn’t get downgraded by rating agencies given the sharp expected rise in the Debt to GDP ratios this year after their stimulus spending package. So, it is likely they will continue to accumulate reserves, allow the weakening of their currency in order to achieve longer term goals. That the USD may depreciate against other currencies will make their task easier.



Author - Tariq Carrimjee

Profile – A Financial consultant and Emerging market specialist. 

Bit about the author - Tariq Carrimjee is Bombay born and raised, US-educated,

and has 25 years of experience in the banking & financial services industries. Now

based in Dubai, Tariq runs a successful business, advising clients on investment

opportunities in emerging markets.