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The Global Currency Conundrum

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.

10 comments on “The Global Currency Conundrum

  1. SP
    December 13, 2010

    I truly agree to your thoughts that currency volatility is threat for global business. I guess US dollar is really going down in last two years. May be it has not yet come out of recession fully. I remember just one year back USD was higher to candian dollar and now its the other way round.

  2. DBertke
    December 13, 2010

    As a part time historian, I can tell you that the current world currency manipulations are just as volatile today as they have ever been.  The only difference today is that we have everyone talking about it daily with world wide communications and confusing the currency issues with useless banter and allegatiions of currency manipulation.

    Throughout time, the value of goods and services has been negotiated between the buyer and the seller.  The face value of a currency is only important within the minter's political domain and the ability to ensure or enforce its worth in daily trading within its local market.  As soon as the currency leaves your country, you have to negotiate its value relative to the currency in use where you go.

    So what is the problem?  There is none! Each currency has a percieved value between the buyer and seller.  The percieved value for each currency is constantly changing due to world events, that's it.  If the buyer is unwilling to pay for your goods and services, then the deal is over or you negotiate a compromise. QED!

    What the world is struggling with currently is the perceived value of each groups currency in relationship to the goods and services each group offers.  If the buyer is desperately in need of the goods or services, then the price goes up.  If the buyer has many places that offer the goods or services, the price goes down.  If you try to fix the costs or value of a given currency, then you create a furtile “Black Market” for goods and services.

    Meanwhile, the bickering will continue, as will the currency manipulations, tax incentives, governement subsidies, etc, until someone comes up with a more sane method of dealing with diverse cultures and the different perceived value for goods and services.

    Good luck in getting that done.

    DAB

     

  3. Barbara Jorgensen
    December 13, 2010

    Great blog, Scott. All the efforts of stabilizing economies has had the exact opposite effect on currency. It is particularly worrisome that the 800-pound gorillas (with apologies to the EU) in this scenario have such polarizing views on how to manage the situation. As one of our moderators points out, it used to be “value” was determined by supply and demand of goods and services. I'm not sure that's the case any more. I think “value” is becoming like “green”–it's over-used and when you dig down deeply enough, you find it doesn't mean anything specific. Or it means different things to different people. In either case, it's  a tenuous situation for those providing goods and services.

  4. stochastic excursion
    December 13, 2010

    The value of the dollar to a given nation state has had more to do with the value of having the United States in its court than anything else.  There was some talk recently about reintroducing gold as a partial anchor against currency swings. 

  5. Scott Raynovich
    December 13, 2010

    DBertke,

    That's absurd.

    You said:

    “So what is the problem?  There is none! Each currency has a percieved value between the buyer and seller.”

    Actually, it's a huge problem. The state goal of central banks is to maintain price stability. If the lack of price stability becomes a global problem (which it has), then they are failing that goal.

    You said you are a “part-time historian” — well if you look at economic history, states that have failed to maintain currency and price stability have resulted in terrible economic failures, and in many cases, war: Take a look at Weimar Germany, Russian Debt Crisis, Argentina, e.t.c. Is that the kind of economic world you want to live in?

    Yes, we could shrug our shoulders and say, “well, stuff happens,” but the point is that the volatility and currency debates are a symptom of deeper problems that need to be resolved if we want to return to a stable economic path.

    –Scott

  6. Scott Raynovich
    December 13, 2010

    Barbara,

    Thanks. Yes you are right in a mercantalist economic expansion such as that launched by China, it is hard to determine how much of  the value creation comes through hard-work and ingenuity and how much of it comes from the fact that many laborers can be exploited to work for pennies per day for a government that can control currency movements against Western trading partners.

    And it looks like the whole thing should come to a head pretty soon…

    –Scott

  7. Ashu001
    December 14, 2010

    DAB,

    I am afraid I have to agree to Disagree with you on this statement,

    “So what is the problem?  There is none!”

    The Biggest losers from this QE /Beggar Thy Neighbour policies are Citizens of those countries which actually use those paper currencies.The purchasing value of their currencies drops and drops dramatically every single month.Until a point is reached when it becomes pointless to save any cash[Which is the ultimate goal of all Western Central Bankers-The Ones in the US and UK mouth it openly].The unfortunate outcome of this is not just specualative bubbles like what we are seeing today but also destruction of productive Capital and capture of Productive Capital by the most non-productive entitity of them all-The State.

    Wish this Fiat Money nonsense could collapse over-night.And all those debts(which will never be paid back) be declared null and void.So the world can just move on and forget this entire.Unfortunately with the Global Banking Cabal in charge its not going to happen soon.

    Regards

    Ashish.

  8. stochastic excursion
    December 14, 2010

    In the recent history of China opening its borders economically, it has talked about reducing its use of the dollar for imports.  Part of the rhetoric has been the concept of a “basket of currencies”, i.e. relying more on the euro.  It's this type of talk that raise hackles on high, not the fact that their labor practices are grossly unfair by American standards.

     

  9. DBertke
    December 14, 2010

    Well Scott,

    If you want currency stability, you have to start with honesty and a frugal government.  Your examples and the historical record verify that governments that spend more than their people can afford to give fall!

    At this point in time, you have many nations trying to game the system by pretending that their currency is worth more than its percieved value and then scream when other nations refuse to agree to their dellusion.

    Is there a currency problem? No there is not. 

    Is their an honesty problem? Yeah big time. 

    Who gets hurt? Everybody.

    What can you do about it? End Deficit Spending!

    Live within your means and treat everyone with the respect and honesty they deserve.  Everything else will fall into line.  If you continue to be dishonest and greedy, well history has many examples of what happens next.

    DAB 

     

  10. Taimoor Zubar
    December 19, 2010

    I agree the volatility in the exchange rates makes it extremely difficult to plan and budget for any firm dealing with global suppliers. In such a situation, would it be a wise decision to buy raw materials in advance if there is a speculation that exchange rate may rise in future? Also, how reliable are the speculations circulating around the foreign exchange markets?

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