October 3, 2018 (see October 17 update below). Next update: November 1, 2018. Visit Search to look at past issues of World Currency Observer (brochure edition).

With a near unanimous expectation that the United States Fed would nudge its key policy interest rate up by 1/4 of 1% last week (which it did, with one further increase expected in 2018), implying that it was already incorporated in market exchange rates, it is not too surprising that a majority of currencies around the world actually moved up a little against the US dollar in September, although there were some important exceptions. The Canada dollar moved up by 1% against the US$ in September, the Mexico peso was up by 2.5%, and the Iceland króna fell by 2.5% versus the US$ (Canada, Mexico and the US have since announced an update of the North America Free Trade Agreement, giving a nice upward bounce to the Canada dollar). But these mixed monthly movements among North America-area currencies left each of them around 3% weaker against the US$ since this time last year. Caribbean and Central America currencies were generally weaker against the US$ in September, with the exception of a strengthening Jamaica dollar (still down 5% since this time last year.) The Brazil peso rose nearly 2% against the US$ in September, leaving it down nearly 30% since this time last year. The Colombia peso rose by 1.3% in September, and the Uruguay peso fell by 2.6% against the US dollar. At around 36.25 pesos/1$US, the Argentina peso is now roughly 1/2 its value at this time last year (down nearly 9% in September, with indications of more international financial support on its way.) Almost all European currencies were stronger against the US$ in September, with the Norway krone up by 3%. The Switzerland franc fell slightly in September. The Turkey lira rose by around 11% against the US$ and the Euro in September (gaining strength steadily through the month), leaving it down around 70% against the US$ since this time last year. The Russia rouble rose against the US$ by 3.5% in September, and the Uzbekistan som fell by nearly 4%, leaving it level against the US$ since this time last year. Among former USSR currencies, the biggest year-over-year by movement by far has been by the Russia rouble, down by 13.5% against the US$. The Yemen rial was down by 17.5% against the US$ in September (down 72.5% since this time last year). The South Africa rand was up by nearly 4% in September (see below). The Tunisia dinar fell by a further 1.5% against the US$ in September, and is now down around 13% since this time last year. The South Sudan pound fell by around 1.5% against the US$ in September, and the Ghana cedi fell by 2.3%. The Liberia dollar (the Liberia central bank was the victim of a theft of newly printed paper currency) is down 34% since this time last year. The Sierra Leone leone fell by 1.4% in September against the US$. The closely-watched (for trade policy reasons) China yuan fell by just over 1/2 of 1% in September against the US$, which means that it is down 3.2% against the US$ since this time last year. The Japan yen fell by 2.3% against the US$ in September. A number of important Asia currencies moved up against the U$ in September - the Australia dollar, New Zealand dollar, South Korea won and Taiwan dollar. The Philippines peso fell by just over 1% against the US$ in September, and is now down 6.3% since this time last year. The India rupee fell by a further 2% in September, after a 3.5% decline in August - the government of India has made moves to ease downward pressure on the rupee (see below). The Sri Lanka rupee fell by nearly 5% against the US$ in September, and the Afghanistan afghani fell by 4.4%. The Thailand baht moved up by 1.5% against the US$ in September, and is now up by 3% against the US$ since this time last year, making the Thailand baht the strongest currency in the Asia region. Copper prices in US rose by around 3% in September, leaving them nearly 5% below their year-ago level, Coffee and cocoa prices are down more than 20% since this time last year, and there is has been a nearly-50% decline in coconut oil prices since then. But world oil prices, in US$ terms, are up nearly 50% since this time last year, after a 6% increase in September.

The South Africa rand, despite a rise in the last week-and-a-half of September, has generally been showing weakness, spurred on by the fact that the South Africa economy has entered recession. GDP figures published by the South Africa government suggest that the recession is largely due a reduction in production in the agriculture sector, which has experienced drought conditions. But, assessing a need to take additional steps to boost the economy, the government announced a number of measures last week, contributing to the end-of-month strengthening. The South Africa list of announced measures include budget reallocations, infrastructure investments and easing of visa requirements for tourists and professionals, but the biggest is the final abandonment of changes to the Mineral and Petroleum Resources Development Amendment Act, which were introduced in 2013, but never implemented, in the face of assessments they would have reduced the international competitiveness of the South Africa mineral production industry (South Africa is, of course, an international mining powerhouse, with large amounts of a wide variety of minerals, including gold). The proposed changes to the mining and petroleum regimes, while regarded as well intentioned, would have created additional hurdles for production and investment in South Africa.

The India rupee fell by 2% against the US$ in September, and is down by around 11% since this time last year (more than many Asian currencies, but not really out of line with movements in exchange rates in other countries around the world). In order to support the India rupee, the government of India has increased duties (tariffs) on 19 “non-essential imports” said to total around 2.5% of imports (one of the products: jet fuel), and has made suggestions that it is willing to make more moves to close the current account deficit. There are suggestions that a very promising path to improvement of the India current account will be to take advantage of the China-US trade war, and to sell more agricultural products to China (examples: cotton, maize and soybeans).

In mid-September an IMF official gave an overview of an intervention, during the 2008 world-wide financial crisis, that the IMF regard (deservedly, we think) as a big success for them: Iceland in 2008 (10 years ago), where contributory factors included broad public support (the small population of Iceland no doubt made it more easy to organise support for the recovery program), moves made by the Iceland government prior to IMF involvement that turned out to be very sound, and enough fiscal room so that painful government austerity measurements could be avoided at the beginning. As noted by the IMF officials, a review of the Iceland episode suggests that best practices include:”.. be parsimonious and well-focused in crisis management policies; allow automatic stabilizers to work to a considerable degree if the fiscal space is available; be pragmatic about the use of capital controls; and insist on bail-in to the maximum extent feasible. Above all, the Icelandic experience has confirmed yet again that success in crisis management hinges on strong domestic ownership.’. Other excerpts from the IMF analysis: “…the IMF approved what remains “among its largest programs relative to the size of the economy—18 percent of Iceland’s GDP or 1,190 percent of Iceland’s quota in the IMF —with almost half of the funding being disbursed in one go up-front. This was extremely fast and it was on a large scale by comparison to other cases…focusing on a very narrow set [of goals] limited to three critical issues: restoring monetary stability; rebuilding the collapsed banking system; and dealing with the huge fiscal deficit that was opening up as a result of the crisis…In fact, to move fast, we initially focused only on the first of the three issues—restoring monetary stability…the central bank took a step in the wrong direction when, in the midst of the discussions, it significantly lowered interest rates. However, this step was soon reversed…we purposefully avoided building any fiscal consolidation into the first year of the program, instead allowing automatic stabilizers to work in full. A time when private demand is collapsing is not the time to slam the brakes on public spending or raise taxes. Thus, the overall fiscal deficit was allowed to surge from about balance before the crisis to a deficit of 14 percent of GDP in 2009. Of course, deferring fiscal consolidation is a luxury only affordable if there is pre-existing fiscal space. Such space was available in Iceland, and the program went ahead and used it…[Iceland] labor market representatives told [the IMF] that they realized that difficult and socially painful measures were unavoidable, but that they would support such measures provided that the IMF was fully on-board…Capital controls provided an essential unburdening of monetary and exchange rate policy at a time when the risks of massive foreign exchange drains were overwhelming, not least from glacier bonds amounting to some 35 percent of GDP. Without such controls the depreciation of the króna and the increase in domestic interest rates would have been much larger, taking a much higher toll on growth and balance sheets…I know that there are those who argue that the economic welfare of Iceland would have been better served over the long run by biting the bullet and lifting capital controls up-front, at the time when the program was launched. I do not belong to that group, and internationally the imposition of such controls under extreme circumstances is today uncontroversial…The challenge facing the authorities was staggering. After the collapse of the currency, total assets of the banking system had peaked at some 900 percent of GDP. If ever there were a situation where the old adage might hold that from extremes there comes clarity, this may have been it: the system was not too big to fail, it was too big to save. The challenge was nothing short of reconstructing an entire banking system—putting public money in where essential while maximizing asset recoveries. There was a strong agreement between the Icelandic and IMF teams—both when the program was initially designed and throughout the program reviews—that it should be an overarching priority to limit the cost to the public sector… The Icelandic authorities had decided to split the banks in an unusual way. Rather than the traditional good bank–bad bank split, the cut was made between the failed banks’ domestic operations and their much larger foreign operations, a move that was designed to allow taxpayer support to focus on shielding the domestic economy. This approach was—as you know—controversial, but it withstood legal challenges…One point that I did not mention was the role of the social welfare system. My personal view—and here I probably reveal my Danish origin—was that it was critical for the social and political support for the program…One area that I would regard as unfinished business is the vital task of fixing financial sector oversight so the whole mess cannot happen again. Let us not forget that the bulk of the imbalances that brought Iceland to crisis had built up in the space of only five years after [Iceland state-owned] banks were privatized in 2003.”

October 17, 2018 update

WCO is not about theory, but we do, from time to time, muse about theoretical issues. For example, there has recently been more attention (Gopinath et many others) to analysis of how merchandise trade balances are affected by exchange rate depreciations against the US$, given that many traded products are invoiced (priced) in US dollars in international markets (examples: soybeans, maize, wheat from the temperate climates, coffee from tropical climates; petroleum; major metals such as gold and zinc). Then, a fall in the value of a currency against the US$ makes imports into the country, of oil and other US$-priced commodities, more expensive, so they will tend to decline. But if a country’s exports are priced in US dollars in international markets at (essentially) one world price for everyone, then the US$ price of the exported goods doesn’t change. But, the exporter has higher profits measured in his/her home currency – the home currency value of revenues goes up; and, as well, the prices of domestic inputs into the export commodity might not change because of the depreciation (contracts, competition, slowness to adjust, etc.), so the profit margin of the exporter may also go up. Okay so far, but the higher profit margins within a country would normally attract more supply –this is true for agricultural commodities which are produced in very competitive within-country conditions, but also even in less competitive conditions (think of what OPEC does with oil production when U$ oil prices move up) - which will put downward pressure on even the most inflexible and far-away-set international US$-denominated price and, when that price does fall, exports will go up, which is what they are supposed to do when there is a depreciation, although with a world price set in a far-away market like Chicago or London, it may not happen right away. (But, there are exceptional cases of strong support for prices, like US domestic sugar prices protected by quotas). There are a few other wrinkles, such as whether the fall in the exchange rate against the US$ is just for the one currency (whether it is a large or small country would matter) or for a group of currencies (such as the emerging market group, the Mercosur group, oil producers, oil consumers, cocoa producers), which would make the commodity supply response stronger. Still, recognition of the widespread invoicing of products in US$ means that our understanding of the response to an exchange rate depreciation has shifted, from a 1:1 drop in the home currency-denominated export price with an immediate impact, to a more complicated response, involving increased profit margins attracting more supply, pushing down the international price of the commodity, which then results in more demand for the product. Something upon which to reflect.

Other things WCO is looking at right now include: reports of a large devaluation of the official value of the Sudan pound, to 47.5/1$US from the former rate of 29, in the first part of October, closing the large gap with the parallel rate; new clauses, on consultation with regard to exchange rates, and restrictions on future deals with “non-market economies” (including, in the eyes of the United States, China), in the revised NAFTA accord among Canada, Mexico and the United States, which will be renamed (it is also some distance from being ratified); and investigation by Australia’s competition commission into profit margins in retail foreign exchange markets, driven to a large extent by the monthly World Bank surveys of foreign exchange transfer costs for foreign exchange remittances across countries.

(World Currency Observer will next be updated on November 1, 2018. Visit Search to look at past issues of World Currency Observer (brochure edition).)