The great "conundrum" of the global markets at the moment -- particularly in technology -- is how the developed and emerging markets will cope with growing economic dichotomies, particularly with regard to currency movements and how they relate to global trade.
Just take a look at the euro/dollar relationship, which during a one-year period has experienced violent swings, with the euro trading up as high as $1.50 and as low as $1.20. It now sits at about $1.30, but such movements over a year -- 20 percent of the currency’s value! -- are quite dramatic and make it very difficult for global companies to plan for.
European Central Bank (ECB) president Jean-Claude Trichet says the more volatile currency movements are a threat to global growth.
"I would only say that, more than ever, I think that exchange rates should reflect economic fundamentals, that excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability, and we will have an occasion to exchange views on that," Trichet said in an October ECB news conference.
In fact, currency volatility has increased worldwide, driven by the stimulative actions sovereign governments have taken in response to growing debt problems. A number of global technology CEOs have commented during recent earnings calls that business is becoming more difficult to predict due to extreme currency movements, given the global nature of the technology market.
Large interventions by central banks have made the global monetary environment more chaotic, controversial, and volatile. The global community protested in November when the US Federal Reserve announced a plan for further "Quantitative Easing," a process by which it will buy nearly $1 trillion in bonds through next year in an effort to keep lending rates low. The global community saw this as an overt bid to lower the value of the US dollar and increase the US competitive edge worldwide.
One of the harshest critics of the Federal Reserve's policy was the People's Republic of China. The US and Chinese economies are inextricably linked, and currency values are crucial to this relationship. China's growth has resulted in a growing trade imbalance with the United States and other large Western countries. Herein lies one of the biggest challenges to the global economy: How can this trade conflict be resolved?
The United States has, in fact, been pursuing stimulative cheap-money policies since the collapse of the tech bubble in 2000. Even during growth stages, however, interest rates remained quite low, enabling the real estate and commodity bubbles to develop -- a phenomenon former Federal Researve Chairman Alan Greenspan referred to as the “conundrum.”
The fact that markets might not always behave according to economics textbooks can be traced back to China, with its hybrid state-run capitalism model. In a normal, market-based economy, China's enormous growth would be causing its currency to rise dramatically, offsetting the natural trade imbalances that develop. But China dictates the range in which its currency trades relative to the US dollar, resulting in a controlled currency peg. Thus, whenever the US dollar falls, its link to the Chinese yuan has the effect of "exporting" inflation to China. In this situation, the trade imbalances become nearly impossible to resolve through normal market forces. In theory, China’s currency would continue to rise until the trade imbalances were erased.
As the global economy recovers and emerging markets return to their high-growth trajectory, you can see almost immediately the challenge that these currency relationships pose as the West pursues stimulative policies and resumes growth: Inflation in China recently hit a 28-month high, rising at a 5 percent pace; food prices are skyrocketing; and crude oil is back at $90 a barrel (from a low near $35 during the peak of the financial crisis). Many analysts believe that the American stimulative policies risk creating a big inflation surge.
In fact, it’s clear that the actions of global central banks are allowing even more money to pour into emerging economies such as China, and the Chinese government does not appear to be doing a good job of managing this liquidity.
This weekend, the world expected the Chinese central bank to raise rates, which would help contain inflation and allow its currency to rise further. China did nothing. This morning, commodities and equities prices are rising around the world. China may be cautious about raising rates or allowing its currency to rise further, because that would lower its competitive edge in the global market by making its products more expensive. But the alternative -- doing nothing -- appears to creating a potential inflationary storm that threatens the global economy.
What do these complex and unnatural currency relationships mean for global business? It means that CFOs worldwide need to be alert to the growing volatility of interest rates, currency movements, and inflation, and prepare accordingly. Perhaps one of the most important tasks ahead is the hedging of raw materials prices. As inflation in China escalates it is likely to push the prices of commodities yet higher.