Who Benefits from the Recent Exchange Rate Shifts?
In recent months, the global economy has been buffeted by a high degree of market volatility that has stemmed from a series of political shocks and economic uncertainty in many areas of the world. The global currency market has been no exception, with the value of many of the world’s most important currencies fluctuating greatly in recent months. On one hand, the high level of political volatility in recent months has led to a major appreciation of most of the world’s safe haven currencies, particularly the US dollar, which has strengthened considerably over the past three years.
On the other side, a host of major currencies have weakened dramatically, both over the past three years as well as in recent months. This is due to a combination of investor concerns over the outlook for those countries’ economies as well as an intentional move by some countries to weaken their currencies in order to promote exports and foreign investment.
One region that is in a position to benefit from the recent currency fluctuations is Europe. For years, we have been arguing that Europe needs weaker euros, pounds and other currencies in order to offset declining domestic market growth with higher levels of export growth to markets further afield. Over the past three years, the euro has lost nearly 25% of its value against the US dollar and this has allowed the Eurozone to regain some of its lost economic competitiveness and to record decent rates of economic growth during this period. As domestic market growth will remain very limited in the Eurozone, a further weakening of the euro would be welcome news for the region’s exporters (if not for inflation-wary German monetary policymakers).
Likewise, the British pound has weakened significantly against the US dollar and other currencies, with much of this weakening occurring in the wake of last summer’s decision by British voters to withdraw the UK from the European Union. Given the disruptions that the EU withdrawal is likely to cause in the coming months, a weaker pound will give the British economy the opportunity to offset some of its export losses to the EU, while maintaining a degree of attractiveness for foreign investors in the UK.
No economies have been impacted more by the recent strength of the US dollar than the United States’ two large neighbors, Canada and Mexico. In previous years, Canadian export competiveness had waned significantly due to the strength of the Canadian dollar, something that cost that country a great deal of investment in its manufacturing sector. Now, with the Canadian dollar having lost nearly one-quarter of its value against the US dollar (despite a slight rebound in recent months), Canada’s struggling manufacturing sector is hopeful that an improvement in the country’s export competitiveness could revive that sector.
Meanwhile, it is clear that the surprise election of Donald Trump as the next president of the United States has added to the volatility on currency markets and no currency has been hit harder by this volatility than Mexico. Over the past few months, the Mexican peso has lost 25% of its value, continuing a downward trend that has been in place over the past few years. While this clearly will improve Mexico’s export competitiveness, the fact that the country is facing potential new trade barriers to the vast US market may offset any gains that the country realizes from a weaker currency.
In recent years, there has been an increasing focus on low-cost manufacturing investment around the world. As production costs in China continue to rise (due in part to a relatively strong yuan), businesses and investors are seeking new locations for manufacturing operations with a focus on exports to wealthier markets. The primary focus for this investment has been on India and Southeast Asia, and here too, currencies have depreciated in recent years vis-à-vis both the US dollar and the Chinese yuan, improving their ability to attract such investment.
Outside of Asia, emerging markets have struggled to grow, but the sharp declines in the values of many currencies for emerging markets outside of Asia could improve these countries’ ability to diversify their economies through foreign investment. However, should a new round of currency depreciations take place, the potential for a full-blown currency war will increase. As such, we can expect a great deal of additional volatility on currency markets in the coming weeks and months and this could add to the risks facing the global economy in 2017.