Wednesday, February 5, 2014

Emerging market currencies in perspective

All emerging market currencies have been falling since taper-talk first surfaced last Spring. But it's a mistake to say that the prospect of Fed tapering has created a crisis for emerging market countries, and/or that the problems of emerging market economies pose some existential threat to the U.S. 


The chart above shows the dollar value of eight emerging market currencies, indexed to 100 as of the end of January, 2007. All of these currencies have been declining since last May, when the Fed began floating the idea of tapering its bond purchases. But as the chart shows, all of these currencies have been falling against the dollar since mid-2011. In short, the weakness of emerging market currencies is nothing new, and it didn't start with taper talk. There is no unifying story that explains what is happening here. Argentina's peso has been clobbered, but the weakness of Chilean peso and the Brazilian real since mid-2011 has only served to reverse the gains these currencies made against the dollar in the four previous years. Over the course of the past seven years, these currencies have pursued widely diverging paths.

The currencies of Russia, Indonesia, India, So. Africa, and Turkey have all moved rather closely in recent years. Not surprisingly, these countries have all had higher inflation than in the U.S. Consider the annual inflation rates for these countries over the past 2-3 years: So. Africa 6%, Russia 7-8%, India 8-9%, Turkey 8%, Indonesia 6-7%. Argentina's annual inflation rate has been at least 25%, so its not surprising that the Argentine peso has been the weakest of the emerging market currencies. If inflation in country A is much higher than inflation in country B, then it is reasonable to expect that the currency of country A will decline relative to the currency of country B. It's therefore not surprising that Chile's inflation rate has been only marginally higher than the U.S. (2-3% since 2011, vs. 2% in the U.S.), and the Chilean peso has been the strongest of the emerging market group.

It's a mistake to pin the problems of these countries and their currencies on the Fed, and it's a mistake to lump them all together.

14 comments:

Mark said...

Thank you Scott, would the inflation in the emerging economies be created via the combination of money printing and/or the continued growth in China?

Scott Grannis said...

Mark: inflation happens when monetary policy is badly conducted. I don't see how China could have been the cause of inflation in a variety of emerging markets. Had to have been something like money printing.

Argentina's currency in circulation has been increasing about 30% a year for quite a few years. This is an obvious example of money printing.

Scott Grannis said...

Mark: inflation happens when monetary policy is badly conducted. I don't see how China could have been the cause of inflation in a variety of emerging markets. Had to have been something like money printing.

Argentina's currency in circulation has been increasing about 30% a year for quite a few years. This is an obvious example of money printing.

Hans said...

This is not what the CFR is reporting.

http://www.cfr.org/emerging-markets/currency-crises-emerging-markets/p31843

I still maintain the premise, that FedZero and it's other forms of manipulation will indeed have consequences.

Hans said...

Another bearish comment by Albert C.D. Edwards regarding the effects of Paper Taper:

http://blogs.marketwatch.com/thetell/2014/02/06/emerging-markets-are-final-tweet-of-doomed-canary-in-coal-mine-says-ultra-bear-albert-edwards/

Scott Grannis said...

I just don't understand how tapering is tightening. For me, monetary policy becomes "tight" when real interest rates rise significantly. Today they are still negative.

Benjamin said...

There are unforseeable and unintended financial consequences, risks and imbalances if the Fed tapers too quickly---but the Fed will probably taper anyway...

Hans said...

"I just don't understand how tapering is tightening. For me, monetary policy becomes "tight" when real interest rates rise significantly. Today they are still negative."

This is indeed true under general economic principals, however, when addressing the Central Banks' Viagra programs any reduction should be viewed as "tighting" just as expansions would be viewed as "loosing."

Monies siting in "reserve" at 25 points simply do not generate enough income for the holder: so it is not surprising to see it deployed in Emerging Markets or else where.

Scott Grannis said...

Bank reserves are not money, and can be found only on the Fed's balance sheet. Bank reserves cannot be invested in anything, much less in emerging markets.

Hans said...

Thank you for your reply, Mr Grannis.

Why would a banker exchange a higher yielding bond, note or MBS for a mere 25 basis points, unless it would suggested to do so by the FBS?

After all, does this not lead to lower revenue and income for the effected institution?

I like many others are baffled..

Scott Grannis said...

Banks are no different from investors and consumers, all of whom have been generally risk-averse since the Great Recession. Risk aversion has taken the form of deleveraging, de-risking (e.g., boosting holdings of cash and cash equivalents), and solidifying balance sheets. Banks have taken in more than $3 trillion in new savings account deposits since 2008, and have preferred to lend the money to the Fed (receiving bank reserves in return), where it will be absolutely safe and default-free.

Mark said...

Thank you, Scott

Additionally, your article on the market correction was I imagine particularly beneficial for many readers as the market has recovered significantly.

Hans said...

So an institution leaves $1 million dollars with the Central Bank and is satisfied with receiving $2500 in interest!

If I were on the board of directors, I would cashier the entire management.

I am sorry but there is something wong with this picture or it indicates a complete and utter fear of future events.

Scott Grannis said...

Hans: as I've argued all along, banks' willingness to accumulate tons of excess reserves is a sign of great risk aversion. Banks' unwillingness to use those reserves to lend aggressively is a sign of risk aversion on the part of banks and on the part of borrowers. Banks can't lend if no one wants to borrow. The huge increase in excess reserves is all about risk aversion.