Hot Money Flows and the
Currency War: Is Globalization on
the Retreat?
Anand Shetty
John Manley
Hagan School of Business, Iona College
1
Hot Money Flows and the Currency
War
• After a short pause following the 2010, the
global currency war is back in full force in
2011.
• The Major Cause: the global imbalance
– Saver Nations versus Consumer Nations
• The main contributors:
– Continued economic weakness in the major
developed economies in the west
– Escalating European sovereign debt problem
2
Hot Money Flows and the Currency
War
• During the financial crisis of 2008-09, “Great
Recession,” China & other emerging countries played
a key role in preventing a major global collapse
• Emerging States maintained their economic growth,
supporting the exports of the developed countries
like the U.S. and preventing a deeper recession
• The western world came out of this recession in
much worse shape than emerging powers.
3
Hot Money Flows and the Currency
War
• With the U.S. unemployment hovering at 10 %
• the European Union facing the sovereign debt crisis,
• Western economic recovery continued to be illusive.
• Policies undertaken to deal with these problems left
the interest rates in the west at the lowest level seen
in recent years and drove their currencies values low
4
11/3/2011
9/3/2011
7/3/2011
5/3/2011
3/3/2011
1/3/2011
11/3/2010
9/3/2010
7/3/2010
5/3/2010
3/3/2010
1/3/2010
11/3/2009
9/3/2009
7/3/2009
5/3/2009
3/3/2009
1/3/2009
11/3/2008
9/3/2008
7/3/2008
5/3/2008
3/3/2008
1/3/2008
11/3/2007
9/3/2007
7/3/2007
5/3/2007
3/3/2007
1/3/2007
Interest Rates
16
14
12
10
Real
8
Yen
CHF
6
USD
GBP
4
Euro
2
0
Source: Pacific exchange rate service
Trading economies.com
5
Source: Pacific exchange rate service
Trading economies.com
Nov-11
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Nov-10
Sep-10
Jul-10
May-10
Mar-10
Jan-10
Nov-09
Sep-09
Jul-09
May-09
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
Jan-08
Nov-07
Sep-07
Jul-07
May-07
Mar-07
Jan-07
Exchange Rate Index
(Dollars/FC)
180
160
140
120
100
Real
Yen
80
CHF
Euro
60
SGD
40
20
0
6
Hot Money Flows and the Currency
War
• In an interconnected world, events and
policies pursued in one country are
transmitted quickly to other countries.
• It could not have been more evident than
what was observed during this financial crisis.
7
Hot Money Flows and the Currency
War
• Growing uncertainty created by European sovereign
debt crisis and the battle between Republicans
leaders and the U.S. President over the budget and
the low yields in the west have driven investors to
the perceived safety of currencies like yen and Swiss
franc and to some high yield markets in the east and
the south.
8
Hot Money Flows: Currency War
• Hot Money: s-t funds seeking best rates
• Hot money flows resulting from the easy
money policies of the west became a major
concern for its trading partners
• With the exception of China, emerging nations
where economic recovery has been strong
were particularly concerned
• Currency exchange values were high against
dollar with dire consequences on their growth
9
Hot Money Flows: Currency War
• Countries with strong economic growth generally
experience upward pressure on inflation
• to control inflation, they resort to tight monetary
policy and a higher interest rate.
• This, in turn, attracts capital (hot money).
• Such capital flows are essentially destabilizing
contributing to greater credit flows, higher inflation
and greater competitive disadvantage.
• Countries receiving funds must respond with
measures to protect their currencies from
appreciation and to forestall the destabilizing effects.
10
Hot Money Flows: Currency War
• As money poured into assets in the East and South,
their stock markets reached multi-year high
• The weakening dollar & increasing hot money flows
led Asia’s biggest economies to influence their own
exchange rates to protect exports and growth
• When countries try to export a way out of trouble,
an environment of competitive depreciation
(currency war) is created.
11
11/1/2011
9/1/2011
7/1/2011
5/1/2011
3/1/2011
1/1/2011
11/1/2010
9/1/2010
7/1/2010
5/1/2010
3/1/2010
1/1/2010
11/1/2009
9/1/2009
7/1/2009
5/1/2009
3/1/2009
1/1/2009
11/1/2008
9/1/2008
7/1/2008
5/1/2008
3/1/2008
1/1/2008
11/1/2007
9/1/2007
7/1/2007
5/1/2007
3/1/2007
1/1/2007
Stock Market Indices
250.00
200.00
150.00
Brazil
Indonedia
100.00
Nzealand
Singapore
S.Africa
50.00
0.00
12
Hot Money Flows: Currency War
• One interesting and rather troubling aspect of the
weakening dollar, the appreciating currency also
appreciates against renminbi
• China has a policy of “fixing” value with the USD
• Imports from China are cheaper and exports from
the other nation are more difficult to maintain.
• Among the currencies most affected: Swiss franc,
New Zealand dollar, Japanese yen, Brazilian real and
Singaporean dollar.
13
Brazil’s Problems
• Brazil was one of the emerging countries hit hard by
the hot money flows.
• Brazil’s rapid economic growth and a high real
interest rate of nearly 6% (Nominal 12.5%) made its
market a powerful draw for foreign investors starved
of investment opportunities in developed markets.
• Brazil has been a vocal critique of the easy money
policies of the developed countries (US and UK).
14
Brazil’s Problems
• Brazil’s finance minister, Guido Mantago, stated: part
of Brazil’s growth is leaking overseas due to the sharp
appreciation of the Real against the Dollar making
exports less competitive and flooding the country
with cheap imports.
• The Real’s value against the US dollar jumped 48%
between July 2009 and July 2011.
• Brazilian real soared to a 12-year high against USD in
July 2011, strongest level since it first floated in 1999
• The strength of real was further aided by the biggest
monthly trade surplus in June 2011.
15
Nov-11
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Nov-10
Sep-10
Jul-10
May-10
Mar-10
Jan-10
Nov-09
Sep-09
Jul-09
May-09
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
Jan-08
Nov-07
Sep-07
Jul-07
May-07
Mar-07
Jan-07
Exchange Rate
Monthly Average
USD/BRL
0.7
0.6
0.5
0.4
0.3
USD/BRL
0.2
0.1
0
Source: Pacific exchange rate service
16
Brazil’s Problems
• To counter the effects of rising real, Brazil was
forced to take actions due to a surge in
imports from China which included
– buying dollars
– requiring banks to hold higher reserves against
foreign exchange reserves
– discouraging bets on dollar weakness, and
– tax breaks and trade barriers to protect
manufacturers hurt by currency appreciation
17
Currency War
• Brazilian actions highlight the dilemma faced
by other fast-growing economies including
Turkey, Chile, Colombia and Russia.
• Central banks have been desperately trying to
stop destabilizing capital inflows.
• Japan launched direct intervention, a move
contemplated by Colombia, Thailand,
Singapore, South Korea and Taiwan.
• China, on other hand, stuck to its longstanding policy of pegging renminbi to USD.
18
Currency War
• The defensive position staked out by the Swiss
National Bank on the 6th of September, 2011 is
another indication of this growing tension.
• The franc had “overvalued” by 35% in real terms
threatening to push the Swiss economy into a very
deep recession when the SNB took action.
• The SNB said it would set a minimum exchange rate
of SF1.20 against euro. (As China, fixing value.)
19
Currency War
• Some Central Banks resorted to less direct
action by resorting to slower monetary
tightening than they would otherwise do.
• Bank of Canada and Reserve Bank of Australia,
for example, have taken a precautionary
pause in its tightening cycle, not resorting to
currency market action.
20
Concluding Observations
• The current problem of hot money flows and
currency wars is rooted in global imbalance
• A coordinated plan by major economies is needed to
ensure a balanced global economic growth
• Efforts of G20 has been less than satisfactory.
• Japan’s intervention in the currency markets to
weaken the yen days before the Cannes summit of
G20 in November 2011 is an indication of the fact
that the G20 is either incapable or too slow to act
21
Concluding Observations
• Individual countries role in a coordinated policy
action is rather demanding one.
• What might work for one country, may not work well
for everyone else.
• FED fighting to prevent recession with easy money
policy when no assistance is coming forth from
politically paralyzed Congress.
• European Union is hamstrung with the sovereign
debt problems and looming recession and has not
been able to do much to help the global recovery.
22
Concluding Observations
• These recent national actions to protect their
currencies has reawakened interest in how to
manage destabilizing capital flows.
• IMF suggests that the world needs rules to
govern the imposition of capital controls.
• At G20 meetings, there is reluctance to
criticize China for holding down the renminbi
which threatens developing country
manufacturers with loss of competitiveness.
23
Concluding Observations
• Lack of willingness on the part of China to change its
exchange rate policy in spite of repeated threat of
legislative action by the U.S. and the retaliatory
actions taken by some by imposing restrictions on
movements of goods and capital will only perpetuate
the current environment of economic instability and
market uncertainty.
• What is notable about all this is that world
organizations such as G7 and G20 have been unable
to do much about the problem
24
Concluding Observations
• Globalization that prospered during the period
of strong performance by major economic
power stands threatened under the current
environment of:
– lagging economic growth in the west,
– mercantilist policies of countries like China, and
– barriers to the free flow of goods and capital
brought about by the currency war.
25
Current Recommendations
• Removing dependence on U.S. dollar as a reserve
currency has been mooted.
– China and Russia have been vocal about their desire to
reduce reliance on the dollar.
– China has moved in the direction of renminbi-based trade
settlements with some of its partners.
– At BRICS summit, Republic of South Africa stated a
transition [time-line unknown] to mutual payments in
national currencies to avoid USD.
• It is difficult to visualize, however, how this would
solve the root problem of global imbalance.
26
Current Recommendations
• Two other alternatives to the reserve currency
problem
– Return to the gold standard, and
– an increased role for special drawing rights (SDR).
• The second one makes more sense than the
first as the history of the gold standard is not a
particularly good one
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Concluding Observations
• A disturbing prediction for the world
– unless countries join together to pursue coordinated policy
to solve the global imbalance,
– currency wars and trade restrictions will continue,
– world economy will remain unstable with continued
financial market uncertainty and global crises.
• What is needed is a set of prudential not retaliatory
policies on the part of each country even if it is
inconvenient for the moment.
• Ultimate solution: resolve the issue of global
imbalance
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Mahalo: Aloha
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