September 2, 2020 (see September 16 update below). Next update: October 1, 2020. Visit Search to look at past issues of World Currency Observer (brochure edition).

Developments related to the COVID-19 pandemic continue to have the strongest influence on currency markets, with the degree to which countries are perceived as having gained more “control” over the pandemic case numbers (which encompass several measurements) generally reflected in the relative strength of their currencies against the US$, but also against 3rd currencies. Economic recovery is marred by some emerging structural changes. Many companies around the world have just announced that they are not recalling all of their laid-off workers, and, to various degrees, are turning some of the mid-March lay-offs into formal departures (although, with economic recovery, these could be reversed quickly). Another issue, perhaps stronger for emerging countries, is the size of the informal economies, with economic activities that officially do not exist, and so do not receive government pandemic-related benefits. One consequence is that the pandemic is bringing informal activities into the formal economy so they can receive government assistance (which will have exchange rate implications-more on the informal economy influences on exchange rates in future WCOs). The mirror image of this, in the more developed countries, is that occupations and activities which are not under the umbrella of government benefit systems (pensions, health care, unemployment benefits) are likely to be brought in. While border closures that prevent cross border shopping are affecting exchange rates, another development has been refinement of techniques for shipping goods across borders, in ways that do not violate country quarantines.

The Canada dollar was up by 2% against the US$ in August (up 1.5% since this time last year), and the Mexico peso was up by 1.5% (down 9% since this time last year). The Costa Rica colón fell by 2% against the US$ in August. The Jamaica dollar fell by 2% in August, and is down by 9% against the US$ since this time last year. South America currencies were generally weaker against the US$ in August (usually attributed to an assessment of their collective response to the Covid-19 pandemic). The Brazil peso fell by 5% against the US$ in August. The Uruguay peso was steady in August, but is down 16% against the US$ since this time last year. The Euro continued to rise in August, up by 1/2 of 1%, and is now up by 7.5% against the US$ since this time last year. The Norway krone was up by 3.5% in August against the US$, and the United Kingdom pound was up by 1.5%. East and Central Europe currencies were generally up against the US$ in August. The Turkey lira was down by 5% in August, and is down by 26% against the US$ since this time last year The Russia rouble was down by nearly 3% against the US$ in August, and is down by nearly 12% since this time last year. The Ukraine hryvnia was up by over 2% in August. The Israel shekel was up by 1.5% against the US$ in August. Africa currencies were generally up against the US$ in August, continuing their July rise (but, see Zambia below). The Sierra Leone leone was down slightly against the US$ in August. There is a long list of Asian currencies which strengthened against the US$ in August, including the China yuan, up by 1.6%, and up by more than 4% since this time last year against the US$. One of the few exceptions was the Indonesia rupee, down by 1% in August. The India rupee was up by nearly 2.5% against the US$ in August, and down by 2.5% since this time last year, The Malaysia ringitt is up by more than 1.5% since this time last year against the US$, and the Singapore dollar is up by more than 2%. Silver prices rose strongly again in August; WCO notices that one of the great historical ratios, the gold-to-silver price ratio, has fallen considerably over the last few months (silver rising faster than gold), and has fallen to a level last seen at the beginning of 2017. Agricultural food prices are up strongly since this time last year. Copper prices are up nearly 20% since this time last year (see Zambia reference below).

Background to the dismissal of the governor of the central bank of Zambia last week includes the fall in the year-over-year value of the Zambia kwacha, the largest such currency movement in Africa–the kwacha was down 25% since this time last year, and down 6% on the month against the US$, in a month when other Africa currencies were rising against the US dollar (WCO has been noting the depreciation of the kwacha for several months, which has exceeded, by a wide margin, the Zambia inflation rate of around 15% per year). 80 per cent of Zambia’s exports are copper, and the world price of copper (US$ terms) has risen by nearly 20% since this time last year. The Zambia government has been moving to assume majority control of copper production, negotiating a reduction in participation by the Swiss firm, Glencore (which has the option of exiting Zambia completely). There are a number of reports of conflicting policy directions from the government (expansionary) and from the central bank (which has kept its eye on, among other things, foreign exchange reserves, which are below the 3-months-of-imports benchmark). More specifically, the particular issue involved in the dismissal appears to be related to a feeling that the central bank had been, in the view of the government, too cautious in the disbursement of a Covid-19 relief fund (the question arising as to whether this “disbursement” would involve a forced expansion of the money supply by the central bank). A press release from the International Monetary Fund noted the change in the governor of the Bank of Zambia, and made a general reference to the importance of central bank operational independence.

September 16, 2020 update

WCO likes to use the purchasing power parity equation for insights into exchange rate movements, on the understanding that PPP has to be properly interpreted, and must not be pushed too far. The variables in the purchasing power parity equation are p_uk = E*p_us, where p_us is a price denominated in US dollars, p_uk is a price denominated in UK pounds, and E is the UK pounds per 1 US$ exchange rate. There is a lot of variation in which prices are chosen, which affects the meaning and truth of the equation, but a good place to start is with something that is absolutely true, like this: if p_us is the world price of a world-traded commodity denominated in US$, such as a barrel of oil (or a kilogram of coffee beans, but not the average US$ price of a Big Mac hamburger in New York, Chicago, Atlanta and San Francisco), then the UK pound price of a barrel of oil, p_uk, is simply p_us converted to pounds with the exchange rate E (p_uk of a barrel of oil=E* p_us). This is a simple equation, but still powerful – for example, it suggests that if the pound-to-US$ exchange rate weakens (E goes up), then the UK pound price of a litre of petrol (gasoline) will go up. The more widely used formulation of PPP defines p_us as the in-the-United-States price of a single commodity, and p_uk as the in-the-UK price of the same commodity. So, if p_uk is less than E* p_us, then a person in the UK will buy the commodity in the UK rather than go out and buy US dollars, and then buy the commodity in the US and ship it back home, so there is no balance of trade movement. But a person in the US can convert her US dollars to pounds at exchange rate E, buy the commodity in the UK and ship it back home (shipping and insurance must be included in her assessment of the UK price, not to mention the cost of searching out what the price is; at the same, the UK person in this example pays none of these costs), so there will be recorded a UK export and a US import, While the idea is clear, it is very hard to come up with measurements of prices that allow the prediction of exchange rates, even for just one commodity, as this example makes clear (to us at WCO, at any rate). It is even more difficult when one uses immensely broad measurements of prices, such as the Consumer Price Index, which includes a breathtaking variety of goods (tradeable) and services (not always tradeable), with differences in locations “averaged out”, and indexes whose weights are different in different countries. Researchers trying to tackle these issues have moved on to other (weaker) hypotheses about the existence of PPP, such as the idea that a test of PPP includes whether the real exchange rate (E* p_us/p_uk, equal to a constant which is not equal to 1) is statistically fixed when other affecting variables are held constant.

Another way to get insights from PPP is to go back to the original formulation of purchasing power parity (such as Cassel in the 1920s, just after World War I, which was a period of very high inflation, but not hyperinflation, in countries around the world), which was not an equation, but an illustration that if two countries have substantially different inflation rates (measured in each country by the in-country price in the local currency of a basket of goods, i.e., a price index), then actual exchange rates must reflect the difference in prices of the baskets (implication for the 1920s: they should not go back to the pre-war fixed exchange rates, backed by gold and (some cases) silver – but of course, many countries did). He did not say, originally, that the exchange rate converted prices of the baskets of good must be equal - rather, that the true value of exchange rates was based on arbitrage (“free movement of goods…somewhat comprehensive trade”). This observation was based on cumulative rates of inflation that varied widely among countries because of World War I, not the much smaller variations we see today among most countries.

(World Currency Observer will next be updated on October 1, 2020. Visit Search to look at past issues of World Currency Observer (brochure edition). For permission-to-quote enquiries, e-mail World Currency Observer at WCO@briargreen.com.)