How A Strong Dollar Could Squeeze Emerging Economies
Prospects of a rising dollar in 2018 could push developing countries like Argentina to take conservative measures like raising interest rates and curbing deficits.
BUENOS AIRES — Argentines have a special relationship with the U.S. dollar. Nobody every really showed us how a currency works, but intuition has helped us protect our savings from the vicissitudes of this country's various political experiments. Today, this "intuition" must be reinforced with some fundamentals, to understand what is happening with the dollar globally and how this will impact us.
The U.S. dollar began a new period in 2017 on the back of several events: the arrival of Donald Trump, improving conditions in Europe (falling unemployment, economic growth), the bottoming out of long declining commodities prices (mainly oil and metals), less bad news from emerging countries (China balancing economic growth and debt, populism fading in Latin America and dissipating threats of a trade war), and central banks continuing their incrementalist approach to raising interest rates.
Thus from January 1, 2017, as Trump entered office, the dollar depreciated on average 13% globally, helping boost returns and the price of other assets. The price of raw materials rose on average 3% (oil 18%, copper 26%, and wheat 7%), and the value of firms also rose. American firms appreciated 28%, German firms 15% and Brazilian firms, 38%. Lastly, the cost of money in dollars over 10 years rose from 2.38 to 2.85%, 1.21 to 2.23% over two years — as the cost of money in euros rose at a slower rate.
Normally the value of money is determined in comparative terms between two countries or currencies (EUR/USD, AUD/USD, BRL/USD etc.). The items that count on a menu of factors are differences in interest rates of countries in their two-year and/or five-year bonds. These are trend indicators of the countries' monetary policies (contractionary or expansive), competitiveness, inflation, growth and economic climate.
In 2018, the dollar may begin a new period of appreciation against emerging currencies like the Argentine peso, Brazilian real or South Korean won. Why?
Firstly, the difference in rates for U.S. two or five-year bonds and European (euro) or Australian (dollar) bonds has peaked again. That is, it is better to save in dollars than euros, as a fixed-rate instrument in the United States gives you 2.23% while a European one yields 0.63%. The difference in rates will, sooner or later, push down the euro and other currencies, so the euro would drop from $1.22 to $1.12 (depreciate 8%), impacting, in turn, the prices of wheat and oil.
Secondly, the natural causes of inflation and U.S. fiscal policies will hasten rate rises.
With inflation: the U.S. jobless rate is at a historical low and Trump's migration policies are making it more difficult to hire and keep workers. So firms already competing to fill vacant jobs will have to pay more to hire and keep them. As people have more money to spend, they will go out and buy more. This will fuel inflation.
Would it be wise to buy dollars?
On the fiscal policy side, U.S. growth could accelerate 3% annually if firms repatriating savings and those favored by tax cuts invest in the United States. Trump's packet of public works could, in turn, boost economic activity, as is currently happening in Argentina. At the same time, the Federal Reserve will stop financing almost 30% of the fiscal deficit as it gradually proceeds with its monetary program.
Finally, if some countries that typically buy U.S. bonds stop or slow their rate of purchase, rates should also rise. If the "new" buyers of U.S. bonds or those financing its deficit, however you would view them, are banks, insurance firms or members of the public, then a 10-year bond should pay 5% made up of 3% growth and 2% inflation.
Overall, current paths indicate inflationary dynamics and thus a need to raise rates, so that in 2018, the dollar should reflect this scenario through appreciation. If that happens, countries with elevated current account deficits and low reserves, net exporters of raw materials and those with low-interest rates will suffer. These could include Turkey, Egypt, Argentina, Brazil and South Korea. But countries with current accounts savings, without domestic rumblings but with reserves and paying higher rates, like Mexico, India, and Indonesia, will suffer less.
So would it be wise to buy dollars? Recently, according to the U.S. CFTC, an oversight body, investors have bet $19 billion on the dollar continuing in the short term to lose value against the euro, because of the fiscal deficit and Trump's calls for a cheaper dollar to reduce costs and boost exports.
Behind all these economic variables is a deeper uncertainty over what we want as a society.