Home' Trinidad and Tobago Guardian : February 8th 2015 Contents FEBRUARY 8 • 2015 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
FINANCE | SBG13
Moneychangers in disarray
Early trade was conducted
in whatever currency was
available. Coins circulated
across borders in a bewil-
dering variety of forms,
creating the need for mid-
dlemen to value one token
against another. These
were the "moneychangers" whom Jesus threw
out of the temple.
Two thousand years later the foreign-
exchange markets are still in turmoil. In January
the Swiss National Bank abandoned its policy
of capping the Swiss franc against the euro,
catching many traders and investors by sur-
As the franc rose by 30 per cent in a few
minutes, many foreign-exchange brokers lost
money. One went bust, and a hedge-fund
manager, Everest Capital, lost so much that
it had to close its main fund. Eastern Europeans
who had taken out mortgages in Swiss francs
also suffered, so much so that Croatia voted
to peg its currency, the kuna, against the franc.
Other currencies also are under pressure.
The Russian ruble has plunged against the
dollar in the face of declining oil prices and
sanctions by the West.
Last week the Reserve Bank of Australia
unveiled a surprise rate cut, sending the Aussie
dollar to its lowest level against the US dollar
since May 2009. Denmark has had to cut
interest rates three times, further and further
into negative territory, in order to discourage
capital inflows that were threatening its peg
against the euro.
What is behind this sudden burst of currency
volatility, which follows a quiet period in for-
In large part it is caused by a divergence in
monetary policy among the big three central
banks: the Federal Reserve, the European Cen-
tral Bank and the Bank of Japan.
The Fed has stopped its asset purchases and
may even push up interest rates this year, but
the Bank of Japan still is implementing a policy
of quantitative easing and the ECB is about
to start one.
These diverging policies reflect economic
fundamentals. The American economy is
growing at a decent rate, while both Japan
and the euro zone are struggling to generate
a sustainable recovery. Like Japan the euro
zone is teetering on the brink of deflation.
Helpful though it is to consumers, the recent
fall in oil prices has sent the euro area s headline
inflation rate negative. Lower inflation is caus-
ing central banks around the world to ease
policy, and 12 have done so since the start of
In such circumstances a lower exchange
rate often is one of the goals of monetary
policy. Since the start of 2014, the yen has
fallen by 11 per cent against the dollar and by
17 per cent against the euro. A weaker currency
makes life easier for exporters, boosting the
economy, and also pushes up import prices
and thus makes deflation less likely. Foreign-
exchange markets are a zero-sum game, how-
For one currency to fall, another must rise.
A country with a rising currency will be tempt-
ed to seek a depreciation of its own, for fear
of importing the deflation that others are
trying to offload.
Foreign-exchange volatility also can cause
problems for companies and investors. That
is why the world used to favor fixed exchange-
rate systems, such as Bretton Woods, which
operated from 1944 into the early 1970s. It is
also why many countries still choose to peg
their currencies to the dollar or the euro. With
the dollar rising and the euro falling, pegging
countries have to follow suit. That may require
tightening monetary policy in dollar-bloc
countries and weakening it in the euro bloc;
hence all those Danish rate cuts.
Pegs produce stability in the short term.
Countries can use them to bolster the credibility
of their economic plans. When Argentina was
trying to shake off the hyperinflation of the
1970s and 1980s, it adopted a currency board
that kept the peso at parity with the dollar.
Britain joined the European exchange-rate
mechanism in 1990 in the hope of importing
some of Germany s inflation-busting success.
Pegs have a number of problems, though.
The first is that other economic goals need to
be subordinated to the exchange rate. That
may not be a problem if the economy with
the peg is closely tied to the one its currency
is pegged to, because monetary-policy changes
in the one will be appropriate in the other.
That was not the case with Britain and Ger-
many in the early 1990s, however, when the
tightening needed to keep the pound in the
ERM proved too painful for the British econ-
omy to bear.
In the era of the classic gold standard, in
the late 19th century, nations were governed
by men drawn from the creditor classes. It
was no surprise that sound money was their
priority. In an era of mass democracy, however,
that is no longer the case. Few voters care
about the exchange rate, but they do care
about borrowing costs and jobs. Markets know
this, giving them an incentive to attack pegs
that lack credibility.
A second problem with pegs relates to the
way that exchange rates are set. One theory,
called purchasing-power parity, holds that
currencies will move in line with the prices
of tradable goods. If one country has a higher
inflation rate than another, its goods will
become more expensive and it will lose market
share. If that happens, its currency should fall
until prices are back in line.
Most currency transactions have little to do
with exports and imports, however. The daily
value of world goods trade in 2013 was US$52
billion, but daily foreign-exchange turnover
in the same year was US$5.3 trillion, a thousand
Investors are forever switching from one
currency to another in search of a better return.
A common tactic is the "carry trade," bor-
rowing money in a currency with a low interest
rate and investing the proceeds in a country
with a higher one.
Such huge flows of money make it harder
to maintain pegs. The ultra-low rates required
by pegs such as Denmark s risk inflating asset
bubbles, and indeed home prices there are
rising. Negative rates also can cut into banks
net interest margins.
A related issue is that companies and banks
in the pegging country may borrow in the tar-
get currency, particularly if it offers lower rates.
If the peg breaks, such companies may get
into deep financial trouble, since the cost of
repaying foreign debts will soar.
That problem was at the heart of the Asian
crisis of the late 1990s, when many "tiger
economies" suddenly saw their currencies fall
against the dollar. The episode echoed the
"third-world debt crisis" of the 1980s, when
many countries, mostly in Latin America,
struggled to pay back their dollar debts.
Both episodes occurred in the middle of
strong dollar runs. Thus, if the dollar is at the
start of another bull market, as many com-
mentators believe, there could be even more
Where might it occur? Many Asian countries
operate with trading bands against the dollar,
rather than targeting a specific rate. Singapore
already has made an adjustment to its band,
allowing its currency to weaken against the
dollar to make sure that its exports stay com-
petitive. Other Asian countries may follow
suit, largely by lowering interest rates. They
have plenty of scope to do this, since lower
commodity prices have reduced inflation and
improved their trading positions.
The big question is what China will do.
After many years in which the yuan steadily
appreciated against the dollar, markets expect
a small depreciation in 2015. The Chinese have
a fine line to tread.
They will not want to lose competitive
ground to their neighbours but, given their
trade surplus, too aggressive a depreciation
would annoy many Americans.
The tectonic plates are shifting in the world
economy, submerging some currencies and
thrusting up others. Either way, a few old
grievances are unshakable.
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