Published in El Mundo, 30/11/2010 Tuesday
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Even it has its costs. After two years, since I took off the latest economic storm, emerging countries top the list of the fastest recoveries. But even it it has its costs.
While many developed countries carry the burden of high unemployment, slow recovery of confidence, risk of deflation and extreme fragility of their financial systems, emerging countries show the opposite: increasing consumer confidence and investors, financial stability and promising growth profiles. But I here its Achilles heel. The robustness of their economies generates a feared threat: the appreciation of their currencies. Against this, the alarms of war of currencies, and its collateral, a trade war are burning.
The most famous case is the monetary tension between China and the United States. But this is not unique. Other countries, among them American, have been tempted to manipulate the price of their currencies to remain competitive. The problem is that if the manipulation is spread, then it could activate a new wave of protectionism, which consumers will be the main losers.
Triggers
The origin of this tension lies in the current imbalance between developed and emerging countries. And in this case, the emerging problem is precisely that the scales are tipped in their favor.
Developed countries have serious trust issues. Consumers have curbed their consumption, in order to save resources to survive in an uncertain future. High unemployment and low confidence in the quick fix has become conservative: they prefer to save and reduce debt rather than consume their own money and debt. This fall in consumption is very bad news for businesses. Many close and others reduce their production scale, which translates into higher unemployment and lower wages, feeding a vicious cycle of lower consumption and lower production.
recession
These traps are social costs, economic and political very important. Economic downturns have profound social effects, and these in turn produce dissatisfaction with politicians who have the helm. The result of the recent elections in the United States is an eloquent example of this chain of discomfort and guilt. Faced with these risks, politicians naturally seek to take action wake up to their economies from the lethargy that threatens their jobs. The stimulus to economies in recession are usually of two types: fiscal and monetary policies. The first result in injection of public spending. The latter are expressed in reduced interest rates and injecting money inorganic.
The idea is that with lower interest rates and more money flowing into debt would be more attractive to families and businesses. Cheaper credit for the first reduces the cost of debt for consumption and reduce incentives to keep money in savings accounts and other financial instruments. Cheaper credit for companies reduce the financial costs of investment. The problem is that when the Federal Reserve injected more dollars into the U.S. economy also put more dollars worldwide. And some of these dollars will travel to other countries in search of better returns. That's when the lower interest rates and the most dollars flowing start to be bad news for emerging economies.
Boys
promising emerging economies have done very well the economic task for the past two decades. Led by China, India and Brazil, developing countries are locomotives operating at relatively high speeds and show excellent prospects for future growth. On the other hand, a good dose of fiscal and monetary discipline have substantially improved their profiles inflation. Today the inflation of the vast majority of emerging countries are in single digits, and in many cases are below 5%.
With the growth of their economies, developing countries has been growing middle class. The growth of this stratum mean consumption growth. More consumption predicts good prospects for investment, and then completes a virtuous circle of supply and demand. Improvements in these two categories are fed also by relatively lower interest rates than shown by these countries for two decades. Thus, new generations know borrowing costs lower than their parents.
negative effects bonanza
The main danger faced by many developing countries is the appreciation of their currencies and the consequent loss of external competitiveness of their industries. Attempts to curb this threat are the fireworks of a general war of currencies and a possible resurgence of protectionism.
The paradox of prosperity is that high capital inflows to a country strengthens its exchange rate domestic currency for foreign exchange. Economic theory teaches first grade if you increase the supply of goods, then its price will fall. This is what happens to the price of foreign currency expressed in domestic currency. For example, the exchange rate of Chile four months ago was 520 Chilean pesos per dollar and a few days ago was 481 Chilean pesos per dollar. This represents an appreciation of about 8%. The lower the exchange rate of pesos per dollar, then less competitive are Chilean products abroad. Something similar has happened in countries like Colombia, India, Singapore and Malaysia, whose findings have accumulated an average of 6.5% last year.
That assessment comes from a high foreign exchange inflows, which in turn has three main sources: a) the increase in raw material prices, b) rate of profit for local industries more than those in countries developed and c) higher interest rates in emerging countries than in developed countries.
The raw material prices have driven increased demand for these two turbines are China and India. Higher commodity prices translate into higher foreign exchange earnings for many emerging economies.
The growth of industrial activity in emerging countries, and prospects for sustainability, resulting in higher rates of profit for real investments in these countries than expected for similar investments in developed countries. This creates an influx of funds that takes the form of foreign direct investment.
Sustained growth has side effects: sooner or later inflation threatens to tow, poor developing countries do not want to see revived. To reduce this threat is necessary to increase local interest rates, so more expensive credit and slow the growth of consumption and investment. The problem is that these local rate increases occur at the same time that developed countries reduce them. The interest rate differential resulting capital drives many to migrate from developed to emerging economies.
currency manipulations and threats of trade wars
face of pressures toward appreciation of their currencies, emerging countries are tempted to manipulate their exchange rates. This is manifested in barriers to capital inflows and direct intervention of central banks and large foreign buyers. The most emblematic case is that of China. This country has many years using restrictions on capital inflows and massive purchases of U.S. Treasuries, as forms to sterilize part of the influx of foreign currency, and thereby maintain an exchange rate of yuan for dollars higher than the result if the foreign exchange market realizes the actual flow of currency to and from the country.
doing so countries seek to sustain a level of export competitiveness, using a kind of exchange allowance. The reaction of countries whose products compete with those favored by this type of exchange rate policy would take two forms: 1) mimic the currency manipulation, which triggered a war of currencies, or 2) set high tariffs on products imported from countries using exchange subsidies, which can cause retaliation that open the door to trade wars.
The potential costs of these two threats demand a global cooperative agreement to avoid escalation of exchange subsidies and protectionism, the principal mourners are consumers and, of course, the poorest.
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