All But Quiet on the Currency Front

Having fun yet? The global currency jolt over the past 17 months is making theme parks jealous. Try as we may, we just don’t seem to have the formula for ending large shifts like this. Keynes tried his best back in the 1930s. Globalization was supposed to help. Derivatives were thought to be the latest remedy. Instead, movements seem to have become more dramatic. Why are we on this wild ride, and is it about to end anytime soon?

How wild is it? Fasten your seat belts. Emerging market currencies are collectively down almost 15% over the past 17 months against the US dollar, with some fluctuating much more than others. Ah, the usual suspects; but with their structural weaknesses, doesn’t this make sense? Far from it; many have learned the lessons of the past and substantially strengthened “their structural currency drivers.” At the same time, many developed countries have seen deeper currency swings. Europe is down 21% in the same time frame, and Canada is down by 19%. Clearly this is not just an emerging market thing. What’s going on? Simply put, the Great Reversal... is profoundly affecting many currencies.

In response, EDC Economics has developed a list of countries that we believe are most exposed to external conditions. Four indicators were used in our assessment: growth in private credit; the current account balance; portfolio flows; and the strength of the country’s commercial environment. We narrowed the list to 43 of the larger emerging markets, and ranked them on overall vulnerability. Argentina and Venezuela made the top 10, for obvious reasons. EU hopeful Turkey ranked third, also unsurprising. More surprising results are Colombia and Peru, countries that have made great strides in their recent development.

In general, we can expect more currency volatility. But volatility alone is not necessarily a sign of structural weakness, for a number of reasons. First, in great part, this is a US thing. As the tide of Fed liquidity retreats, the backward current is affecting almost all non-US markets – it’s almost impossible to resist. In fact, those that are resisting are paying the price. China’s heavily managed renminbi is down only 3.2% against the USD, on a year to date basis, mostly because of the August devaluation, and it looks like China’s exports are getting hammered. Second, past fallout from market swings has led many emerging markets to restructure in ways that are insulating them more from current movements. Among these changes are beefing up foreign currency reserves; minimizing hard-currency debt exposure; reducing foreign-held debt ratios; and creating rainy day funds. On the corporate side, among the BRICS, all but one country have foreign-currency debt at less than 40% of total outstanding debt. Third, the currencies of resource-dependent markets fluctuate with commodity prices, which are clearly in freefall. A good few emerging markets have constructed financial shock absorbers for this, but the fallout is almost impossible to avoid.

So, what’s the effect of all this mayhem on Canadian exporters? First, a huge gain in competitiveness with the U.S., which also happens to be leading the global growth charge. Second, our success in the US shouldn’t give the impression that it’s the same everywhere else. Far from it; while on balance, Canada has actually depreciated against all our non-US trading partners, it’s by just 2.8% in the past 17 months. Against Mexico, we are up by over 3%, and we have also appreciated against Brazil, Russia and South Africa. Granted, much non-US trade is conducted in USD, but the bilateral math is likely leading to discounts: exporters should still expect strong price competition. Finally, currency fluctuations can dissuade already-tentative exporters from pursuing foreign sales, and even more skittish international investors from finalizing direct investment projects abroad. But inside this threat is also an opportunity.

The bottom line? In today’s cautionary climate, currency volatility isn’t exactly helpful. What’s different about today’s currency swings is that they can be directly traced to renewed global growth, and as such, it seems that volatility is here to stay, for now. Those with the stomach and creativity to manage through the mayhem stand to gain – perhaps like never before.

This has been written by Peter Hall, EDC Vice-President and Chief Economist.