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 lots 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 thats about US$316 million on average each. Could Brazil afford to pay for this particular? Of course not. The taxpayer had to foot the bill.

But not even the actual taxpayer could afford it.

In 2014 South america collected about US$288 billion in tax revenues. A deficiency of US$28 billion. That shortfall is if you allocate all the money to the event. Dont forget those tax receipts are money for running the country as well. Things like health, education and infrastructure. Its actually likely the taxpayer will foot the bill for decades to come.

This tournament was supposed to reinvigorate Brazils economy. The government was hoping it would spur growth and attract investment. Put Brazil properly on the world stage.

It didnt.

It feels like this might have been Brazils last roll of the dice. A way to arise the economy from its emerging economy peers. But they didnt realise is that theyll always be an emerging economy. At least, when you compare them to the actual might of the US or China

But Brazil bet the house. And even chose to host the other biggest event in the world, the 2016 Olympics.

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

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

Thats great if youre heading to the games from the US on holiday. Its not so great when youre trying to host the two biggest events in the world consecutive. Its thrown the Brazilian economy into a tailspin.

So why is the real therefore weak? What did South america do, aside from maybe be considered a little overambitious? How come now the actual is up there with the worst performing currencies in the world? Well as Jim Rickards, Strategist for Strategic Intelligence explains within todays essay its all down to the Forex Wars playing out amongst the worlds Big Four C All of us, China, Japan and European countries.

Of course its not just Brazil. Because youll see Jim highlights the plight of Korea also. In fact these wars effect all emerging economies. You see when the Big Four engage in their Currency Wars, they play to win, and everyone else loses. Especially the rising economies like Brazil and Korea.

Regards,

Sam

Who Wins the Forex War: Emerging Markets Vs the Big Four?

By Jim Rickards, Strategist, Strategic Intelligence

For better or worse, emerging marketplaces have become roadkill in the currency conflicts.

Perhaps collateral damage is a better term for it, since collateral damage is used to describe innocent victims of battling among hostile adversaries.

All wars produce collateral damage, and the currency wars are no exclusion.

The major adversaries in the forex wars are the US, China, Europe and Japan.

Each of those four economic powers is actually confronted with the same dilemma. There is too much debt in the world, and never enough growth.

If growth were strong, the debt would be workable and countries wouldnt care a lot if one player tried to adjust its currency. But development is not strong; its weak. And getting weaker all over the world.

And sovereign debt just keeps growing.

Its easy to make fun of nations like Japan that have debt-to-GDP percentages over 200%, but the US and China are not that much behind and are catching up quick.

The whole world is beginning to look such as Greece.

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

If nominal growth is booming faster than your deficit, then the debt-to-GDP ratio goes down as well as your sovereign debt is viewed as sustainable.

The reverse is happening.

Deficits persist in the main economies, but nominal development is weak. In fact, minimal growth in some countries, including the US and Japan occasionally, is actually negative, in part because rising cost of living has turned to deflation.

Real growth is essential, but when it comes to paying the money you owe, nominal growth is what counts, because debt is paid in nominal dollars. In a world of deflation, nominal growth is actually?lower?than real growth. The world of sovereign debt management has been turned upside down.

The main economic powers are battling deflation by devaluing their currencies.

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

These greater import prices feed with the supply chain and put upward cost pressure on finished items and competing products.

The issue is that not everyone can devalue at the same time; countries have to take turns.

China were built with a weak yuan policy in 2009. By 2011, the US had engineered a weak dollar. Beginning in late 2012, Japan orchestrated the fragile yen with Abenomics.

By mid-2014, it was time for that weak euro, which was achieved by the ECB using negative rates of interest and quantitative easing. The major financial systems keep passing the forex wars canteen, hoping that everyone could possibly get just enough relief to keep the game going.

Still, robust global growth is nowhere in sight.

Where performs this leave emerging markets?

Unfortunately on their behalf, emerging markets are simply not big enough or important enough to factor into the calculations of the major economic powers.

Its not too the big central banks dont treatment; its just that there are limits as to the they can do. The US, The far east, Japan and Europe, the actual Big Four, account for almost two-thirds of global Gross domestic product. All of the other developed economies and also the emerging markets combined account for the remaining third. As far as the Big Four are concerned, the rest of the globe are just along for the ride.

When the Big Four fight the currency wars, sometimes these people win and sometimes they lose.

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

Heres why.

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

A weak forex in an emerging-market economy also causes it to be harder to pay off dollar-denominated corporate debt. This can lead to debt defaults and much more capital flight.

In a worst of all, you can have a full-blown emerging-market meltdown of the kind that happened in 1997C98.

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

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

So a weak currency causes funds flight and asset accidents, and a strong currency causes recession and hurts exports.

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

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

But strong growth isn’t in sight.

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

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

Emerging market financial systems dont 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 over article first appeared as a Strategic Intelligence weekly update