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.

Javier Frachi


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.

Photo: EMartin Zabala/ZUMA

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.

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European Debt? The First Question For Merkel's Successor

Across southern Europe, all eyes are on the German elections, as they hope a change of government might bring about reforms to the EU Stability Pact.

Angela Merkel at a campaign event of CDU party, Stralsund, Sep 2021

Tobias Kaiser, Virginia Kirst, Martina Meister


BERLIN — Finance Minister Olaf Scholz (SPD) is the front-runner, according to recent polls, to become Germany's next chancellor. Little wonder then that he's attracting attention not just within the country, but from neighbors across Europe who are watching and listening to his every word.

That was certainly the case this past weekend in Brdo, Slovenia, where the minister met with his European counterparts. And of particular interest for those in attendance is where Scholz stands on the issue of debt-rule reform for the eurozone, a subject that is expected to be hotly debated among EU members in the coming months.

France, which holds its own elections early next year, has already made its position clear. "When it comes to the Stability and Growth Pact, we need new rules," said Bruno Le Maire, France's minister of the economy and finance, at the meeting in Slovenia. "We need simpler rules that take the economic reality into account. That is what France will be arguing for in the coming weeks."

The economic reality for eurozone countries is an average national debt of 100% of GDP. Only Luxemburg is currently meeting the two central requirements of the Maastricht Treaty: That national debt must be less than 60% of GDP and the deficit should be no more than 3%. For the moment, these rules have been set aside due to the coronavirus crisis, but next year national leaders must decide how to go forward and whether the rules should be reinstated in 2023.

Europe's north-south divide lives on

The debate looks set to be intense. Fiscally conservative countries, above all Austria and the Netherlands, are against relaxing the rules as they recently made very clear in a joint position paper on the subject. In contrast, southern European countries that are dealing with high levels of national debt believe that now is the moment to relax the rules.

Those governments are calling for countries to be given more freedom over their levels of national debt so that the economy, which is recovering remarkably quickly thanks to coronavirus spending and the European Central Bank's relaxation of its fiscal policy, can continue to grow.

Despite its clear stance on the issue, Paris hasn't yet gone on the offensive.

The rules must be "adapted to fit the new reality," said Spanish Finance Minister Nadia Calviño in Brdo. She says the eurozone needs "new rules that work." Her Belgian counterpart agreed. The national debts in both countries currently stand at over 100% of GDP. The same is true of France, Italy, Portugal, Greece and Cyprus.

Officials there will be keeping a close eye on the German elections — and the subsequent coalition negotiations. Along with France, Germany still sets the tone in the EU, and Berlin's stance on the brewing conflict will depend largely on what the coalition government looks like.

A key question is which party Germany's next finance minister comes from. In their election campaign, the Greens have called for the debt rules to be revised so that in the future they support rather than hinder public investment. The FDP, however, wants to reinstate the Maastricht Treaty rules exactly as they were and ensure they are more strictly enforced than before.

This demand is unlikely to gain traction at the EU level because too many countries would still be breaking the rules for years to come. There is already a consensus that they should be reformed; what is still at stake is how far these reforms should go.

Mario Draghi on stage in Bologna

Prime Minister Mario Draghi at an event in Bologna, Italy — Photo: Brancolini/ROPI/ZUMA

Time for Draghi to step up?

Despite its clear stance on the issue, Paris hasn't yet gone on the offensive. That having been said, starting in January, France will take over the presidency of the EU Council for a period that will coincide with its presidential election campaign. And it's likely that Macron's main rival, right-wing populist Marine Le Pen, will put the reforms front and center, especially since she has long argued against Germany and in favor of more freedom.

Rome is putting its faith in the negotiating skills of Prime Minister Mario Draghi, a former head of the European Central Bank. Draghi is a respected EU finance expert at the debating table and can be of great service to Italy precisely at a moment when Merkel's departure may see Germany represented by a politician with less experience at these kinds of drawn-out summits, where discussions go on long into the night.

The Stability and Growth pact may survive unscathed.

Regardless of how heated the debates turn out to be, the Stability and Growth Pact may well survive the conflict unscathed, as its symbolic value may make revising the agreement itself practically impossible. Instead, the aim will be to rewrite the rules that govern how the Pact should be interpreted: regulations, in other words, about how the deficit and national debt should be calculated.

One possible change would be to allow future borrowing for environmental investments to be discounted. France is not alone in calling for that. European Commissioner for Economy Paolo Gentiloni has also added his voice.

The European Commission is assuming that the debate may drag on for some time. The rules — set aside during the pandemic — are supposed to come into force again at the start of 2023.

The Commission is already preparing for the possibility that they could be reactivated without any reforms. They are investigating how the flexibility that has already been built into the debt laws could be used to ensure that a large swathe of eurozone countries don't automatically find themselves contravening them, representatives explained.

The Commission will present its recommendations for reforms, which will serve as a basis for the countries' negotiations, in December. By that point, the results of the German elections will be known, as well as possibly the coalition negotiations. And we might have a clearer idea of how intense the fight over Europe's debt rules could become — and whether the hopes of the southern countries could become reality.

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