If there is one thing you can count on in global currency markets, and in emerging markets in particular, it is exchange rate volatility. The present sell-off in emerging market stocks and currencies, as evidenced by the chart below compiled with data from Oanda.com, is certainly eye opening, but in no way unprecedented. What is unprecedented, however, is the grim prognosis perhaps facing these nations’ economies.
Emerging markets have always carried a heightened element of risk. These unique risks set them apart and include factors that are almost unheard of when one is conditioned to operating solely in developed economies. Extreme illiquidity, disasters both man-made and natural, heightened political sensitivity, and infrastructure challenges have been cited as important factors in the past and are well documented in “So You’ve Decided to Trade in the Emerging Market” guides.
Currently, and less expectedly, it is not the quirks common to emerging markets that are thwarting their progress. Classic “Economics 101” factors are undermining whatever footing these fledgling markets hold. Commodity prices are at multi-year lows, and with developed nations struggling with their own domestic economic challenges, they are not demonstrating the demand for emerging market exports that they have in the past.
Of course, when demand falls, price typically follows suit. This is exactly what is happening with respect to commodity prices and local currencies. Both are plummeting sharply and for the same reasons.
Traditionally, central banks have been known to let domestic currencies falter when they feel a country can export its way out of an economic downturn. Though central banks would refuse to acknowledge this, it is part of the cycle: a weak domestic currency boosts exports, which boosts growth, which boosts imports. Through this process, everyone wins in the end. At the moment, however, the cycle is lagging.
Realized global growth rates have been relatively anemic of late. Economic forecasters are predicting that this will remain the case for the foreseeable future for many of the G7 industrialized nations. As demonstrated by the OECD’s estimates for growth, on the high end, these countries can expect to just under two percent growth. This is evidenced on the adjacent chart.
Even China, with its voracious appetite for materials to fuel its once scorching growth, is expected to register a decline.
Intervention, or stepped up intervention in certain cases where the central bank would purchase their home currency using their foreign exchange reserves, is a possible remedy. This is not without running the risk, though, of primarily depleting reserves. Another remedy could be to cut interest rates, which happen to hover near recent historic highs in several emerging market countries. In doing so though, these countries run the risk of pushing badly needed foreign investors out along with their money.
In the United States, markets are pricing in the exact opposite move. The Fed is expected to start raising rates soon. This will likely tap the metaphoric “economic decelerator” while also making the U.S. a relative belle of the ball when it comes to interest rate yield.
A twenty-five basis point rise may sound miniscule, but coupled with the proven security of investing in the U.S. and the symbolic message it sends about the state of the U.S. economy, it could be enough to tip our economic scales. This action would also signal to the market that more rate hikes could follow.
Other remedies for concerns surrounding emerging markets include diversifying developing countries’ economies, moving them away from sole reliance on commodities and exporting. Such measures, however, would take many years to implement effectively. The retooling of a nation’s economy is not a practical short term solution.
For individuals who can afford them, there remain many bargains to be found overseas. A relatively tiny proportion of small and medium-sized businesses in the U.S. account for an outsized portion of national imports. The same goes for exports, but given the landscape in emerging markets in particular, the term “buyer’s market” resonates much more favorably here. Nonetheless, all economic cycles come around eventually.
The designation of “multi-national” is not for all companies to embrace. But if you are importing, it might be worth considering expanding your import operations. This is not only an opportunity to improve pricing. It may benefit terms of trade as well. If you are not importing, it is certainly worth exploring what opportunities lay overseas for the exact same reasons.
Challenges will always remain — especially in the emerging markets. But the economic benefit to be had overseas makes the prospect of growing internationally more attractive now than ever before.
There are many constants that will be present when operating internationally. Underlying volatility is at the top of the list. Combining the economic opportunity noted above with currency hedging tools available in the market to minimize risks makes international operations an even more appealing prospect.
People jokingly refer to economics as the “dismal science.” The seemingly hopeless downturn in emerging markets might only seem to bolster that notion. Many developing countries are certainly in a rough patch and their short term prospects are grim.
There is another popular joke in economics, too. It is about the proverbial one-armed economist who is only able to see things “on the one hand.” It is clear, though that in this current market, one can certainly say that on the one-hand, the emerging market situation is bleak and fraught with risk. On the other hand though, within that risk rests enormous opportunity.
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