The hangover from the financial crisis is proving to be prolonged and more painful than many may have thought. The great deleveraging of the west is weighing on growth to the extent where some central banks, most notably the Federal Reserve, are expected to announce further shots of monetary policy to boost their flagging economies Kathleen Brooks, Research Director, FOREX.com UK, analyses the global implications
This theme is being played out in foreign exchange markets too. After acting like a safe haven during the peak of the financial crisis, investors have ditched the dollar as the reality of sluggish growth requiring ultra-low interest rates for the foreseeable future combined with more monetary stimulus from the Fed, erodes the value of the greenback.
And the U.S. isn’t alone. The UK is poised to embark on a deficit reduction plan to reduce its debt pile, which currently stands at 11.5 per cent. Meanwhile, although public finances look fairly healthy in Europe, this is only in the aggregate. The eurozone budget deficit stands at 6.3 per cent, but the financial position of some of the peripheral economies is astonishingly bad. It took a good seven years to spend all of this money; it will take at least the same amount of time to pay it back. The big repayment won’t be half as fun as spending it, as consumers reassess their priorities and leave the credit cards at home.
Since currencies tend to appreciate in countries where the growth outlook is good and interest rates are rising relative to elsewhere, we are seeing the beginning of what may be a new world order in FX. Investment flows into fast-growing economies (read those not crippled with high household and public debt levels) are rising rapidly. For example, net capital flows into emerging markets in Asia are forecast to reach more than $270bn in 2010 and a similarly large sum in 2011, according to the Institute of International Finance.
This new order in FX is split along regional lines and we are witnessing a huge shift of capital from the sluggish west to the advancing economies in the east. Asian FX has been a main beneficiary of these new capital flows, and currencies like the Singapore dollar have strengthened rapidly against the greenback since the start of this year.
But it is also benefiting countries with proximity to the east. Australia is the perfect economy for many investors right now. It is benefiting from the mining boom fuelled by strong growth in China, and it is a capitalist, English-speaking economy making it accessible to many investors in the west. Australia is an attractive destination for money managers who are reallocating their portfolios out of the west and into the east, meaning that western retirees may soon be living off of the profits from their eastern pension funds.
These huge flows of money were in place before the financial crisis; however, the harsh shock it has caused to some of the major economies has accelerated the flow.
Commentators now fear that further quantitative easing in the west may also ride on this liquidity wave to the east.
While this shift is a fact of the new world order, it will suffer teething problems. We have already seen some Asian economies including South Korea and Thailand impose capital regulation to try and limit speculative money flows into their economies. The Brazilian finance minister went as far as to call it the new “currency war”.
But that is missing the point. The new world order is in its infancy, and Asian and emerging world currencies will need to grow into their role as the ‘strong ones’.
Singapore has taken the lead on this front by announcing it would widen its trading band versus the U.S. dollar, therefore allowing the Singapore dollar to appreciate. It will be interesting to see if other emerging Asian nations follow suit.