Who Wins in the Currency War: Emerging Markets versus the Big Four?

In July 2014 Brazil was web host to the biggest sports event in the world, the FIFA World Cup.

A big event like this costs money. And a lot of it.

All in Brazil expected around US$15 billion to host the event. On stadiums alone these people spent around US$3.9 billion. For 12 stadiums that’s around US$316 million on average every. Could Brazil afford to purchase this? Of course not. The citizen had to foot the bill.

But not even the taxpayer could afford it.

In 2014 Brazil collected about US$288 billion in tax revenues. A shortfall of US$28 billion. That shortfall is if you set aside all the money to the event. Don’t forget those tax receipts are money for running the nation too. Things like health, training and infrastructure. It’s actually most likely the taxpayer will foot the bill for decades to come.

This tournament was supposed to reinvigorate Brazil’s economic climate. The government was hoping it would spur growth and attract investment. Put Brazil properly around the world stage.

It didn’t.

It feels like this might have been Brazil’s last roll of the dice. A way to emerge the economy from its emerging economy peers. But they didn’t realise is the fact that they’ll always be an emerging economic climate. At least, when you compare them to the actual might of the US or China…

But Brazil bet the house. As well as decided to host the other greatest event in the world, the 2016 Olympic games.

Tommy Andersson in his 2008 paper, ‘Impact of Mega-Events on the Economy’ estimates on average the economic benefit of an Olympic games is under US$10 billion. Estimates would be the Olympics will cost around US$16 billion.

To make matters worse, since 2011 the actual Brazilian real is over 59% weaker against the US dollar.

That’s great if you’re heading to the video games from the US on holiday. It isn’t so great when you’re trying to host the two biggest events in the world back to back. It’s thrown the Brazilian economy into a tailspin.

So why is the real so weak? Exactly what did Brazil do, apart from maybe be a little overambitious? How come now the real is up presently there with the worst performing foreign currencies in the world? Well as Jim Rickards, Strategist for Strategic Intelligence explains in today’s essay it’s all down to the Currency Wars playing out amongst the world’s ‘Big Four’ – US, China, Japan as well as Europe.

Of course it’s not just South america. As you’ll see Jim illustrates the plight of Korea also. In fact these wars impact all emerging economies. You see when the Big 4 play out their Currency Conflicts, they play to win, and everyone else loses. Especially the actual emerging economies like South america and Korea.

Regards,

Sam

Who Wins the Currency War: Emerging Marketplaces Vs the Big Four?

By Rick Rickards, Strategist, Strategic Intelligence

For better or worse, emerging markets have become roadkill in the currency wars.

Perhaps ‘collateral damage’ is a better term for this, since collateral damage is used to describe innocent victims associated with fighting among hostile adversaries.

All wars produce collateral harm, and the currency wars are no exception.

The major adversaries within the currency wars are the US, China, Europe and Japan.

Each of these four economic forces is confronted with the same dilemma. There is too much debt in the world, and not enough growth.

If growth were strong, the debt would be manageable and countries would not care much if one player tried to manipulate its forex. But growth is not powerful; it’s weak. And getting weaker all over the world.

And sovereign debt just keeps growing.

It’s easy to make fun of countries such as Japan that have debt-to-GDP ratios over 200%, but the US and The far east are not that far at the rear of and are catching up fast.

The whole world is beginning to look like A holiday in greece.

The key to solving the sovereign financial debt problem is nominal growth, which consists of real growth plus inflation.

If nominal growth is rising faster than your deficit, then the debt-to-GDP ratio goes down and your sovereign debts are viewed as sustainable.

The opposite is happening.

Deficits persist in the major economies, but nominal growth is actually weak. In fact, nominal development in some countries, including the US and Japan on occasion, is really negative, in part because inflation offers turned to deflation.

Real growth is important, however when it comes to paying your debts, minimal growth is what counts, because debt is paid in nominal dollars. In a world of deflation, minimal growth is actually?lower?than real growth. The world of sovereign debt management has been turned upside down.

The major financial powers are fighting deflation by devaluing their currencies.

A devaluation raises the price of imports such as energy, commodities and manufactured goods.

These higher import prices feed through the logistics and put upward price pressure on finished goods and competing products.

The problem is that does not everyone can devalue at once; nations have to take turns.

China had a fragile yuan policy in 2009. By 2011, the US had engineered a weak dollar. Beginning in late Next year, Japan orchestrated the weak yen with Abenomics.

By mid-2014, it was time for the fragile euro, which was achieved through the ECB using negative interest rates as well as quantitative easing. The major economies keep passing the currency wars canteen, hoping that everyone can get just enough relief to keep the game heading.

Still, robust global growth is nowhere in sight.

Where does this depart emerging markets?

Unfortunately for them, emerging markets are simply not large enough or important enough to factor into the calculations of the main economic powers.

It’s not that the large central banks don’t care; it’s just that there are limits to what they can do. The US, China, Japan and Europe, the ‘Big Four’, account for almost two-thirds of global Gross domestic product. All of the other developed economies and the emerging markets combined take into account the remaining third. As far as the Big Four are concerned, the rest of the world are just along for the trip.

When the Big Four fight the actual currency wars, sometimes they win and sometimes they shed.

But the emerging markets always shed. The emerging markets have been painted into a corner and cannot escape the room.

Here’s why.

When a good emerging-market currency weakens, capital leaves the nation and heads for strong-currency locations such as the US. This funds flight causes declines within asset markets such as stocks and real estate.

A weak currency in an emerging-market economy also makes it harder to pay off dollar-denominated corporate financial debt. This can lead to debt defaults and even more capital flight.

In a worst case, you can have a full-blown emerging-market meltdown of the kind that happened in 1997-98.

But when an emerging-market currency strengthens, its exporters suffer, and its tourism sector can be hurt also. This is happening in Korea these days.

The relatively strong won has the Korean economy on the brink of economic downturn because they are losing export competitiveness to Japan, Taiwan and other competitors.

So a weak currency causes funds flight and asset crashes, and a strong currency leads to recession and hurts exports.

Emerging financial markets are between a rock and a difficult place, and they will stay there so long as the Big Four are battling the currency wars.

One means to fix this dilemma is a resumption associated with strong economic growth in the Big Four. In a world of strong growth and stable forex rates, emerging markets can succeed with exports of commodities and manufactured goods as well as tourism and services.

But strong growth is not in sight.

Another solution is capital controls. But capital controls tend to be discouraged by the IMF and are considered a sign of desperation.

Neither strong development nor capital controls are on the horizon right now, therefore emerging markets will remain in this ‘heads you win, tails I lose’ posture relative to the Big Four.

Emerging market financial systems don’t have the right type of weaponry to defend themselves in currency wars.

The emerging markets are in position to lose both ways.

Regards,

Jim Rickards,

Strategist, Strategic Intelligence

Ed Note: the above article first appeared like a Strategic Intelligence weekly update