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Hot Money Flows and the Currency War: Is Globalization on the Retreat?


Hot Money Flows and the Currency War: Is Globalization on the Retreat? Anand Shetty John Manley Hagan School of Business, Iona College * Hot Money Flows and the ... – PowerPoint PPT presentation

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Title: Hot Money Flows and the Currency War: Is Globalization on the Retreat?

Hot Money Flows and the Currency War Is
Globalization on the Retreat?
  • Anand Shetty
  • John Manley
  • Hagan School of Business, Iona College

Hot Money Flows and the Currency War
  • After a short pause following the 2010, the
    global currency war is back in full force in
  • The Major Cause the global imbalance
  • Saver Nations versus Consumer Nations
  • The main contributors
  • Continued economic weakness in the major
    developed economies in the west
  • Escalating European sovereign debt problem

Hot Money Flows and the Currency War
  • During the financial crisis of 2008-09, Great
    Recession, China other emerging countries
    played a key role in preventing a major global
  • Emerging States maintained their economic growth,
    supporting the exports of the developed countries
    like the U.S. and preventing a deeper recession
  • The western world came out of this recession in
    much worse shape than emerging powers.

Hot Money Flows and the Currency War
  • With the U.S. unemployment hovering at 10
  • the European Union facing the sovereign debt
  • Western economic recovery continued to be
  • Policies undertaken to deal with these problems
    left the interest rates in the west at the lowest
    level seen in recent years and drove their
    currencies values low

Interest Rates
Source Pacific exchange rate service
Exchange Rate Index(Dollars/FC)
Source Pacific exchange rate service
Hot Money Flows and the Currency War
  • In an interconnected world, events and policies
    pursued in one country are transmitted quickly to
    other countries.
  • It could not have been more evident than what was
    observed during this financial crisis.

Hot Money Flows and the Currency War
  • Growing uncertainty created by European sovereign
    debt crisis and the battle between Republicans
    leaders and the U.S. President over the budget
    and the low yields in the west have driven
    investors to the perceived safety of currencies
    like yen and Swiss franc and to some high yield
    markets in the east and the south.

Hot Money Flows Currency War
  • Hot Money s-t funds seeking best rates
  • Hot money flows resulting from the easy money
    policies of the west became a major concern for
    its trading partners
  • With the exception of China, emerging nations
    where economic recovery has been strong were
    particularly concerned
  • Currency exchange values were high against dollar
    with dire consequences on their growth

Hot Money Flows Currency War
  • Countries with strong economic growth generally
    experience upward pressure on inflation
  • to control inflation, they resort to tight
    monetary policy and a higher interest rate.
  • This, in turn, attracts capital (hot money).
  • Such capital flows are essentially destabilizing
    contributing to greater credit flows, higher
    inflation and greater competitive disadvantage.
  • Countries receiving funds must respond with
    measures to protect their currencies from
    appreciation and to forestall the destabilizing

Hot Money Flows Currency War
  • As money poured into assets in the East and
    South, their stock markets reached multi-year
  • The weakening dollar increasing hot money flows
    led Asias biggest economies to influence their
    own exchange rates to protect exports and growth
  • When countries try to export a way out of
    trouble, an environment of competitive
    depreciation (currency war) is created.

Stock Market Indices
Hot Money Flows Currency War
  • One interesting and rather troubling aspect of
    the weakening dollar, the appreciating currency
    also appreciates against renminbi
  • China has a policy of fixing value with the USD
  • Imports from China are cheaper and exports from
    the other nation are more difficult to maintain.
  • Among the currencies most affected Swiss franc,
    New Zealand dollar, Japanese yen, Brazilian real
    and Singaporean dollar.

Brazils Problems
  • Brazil was one of the emerging countries hit hard
    by the hot money flows.
  • Brazils rapid economic growth and a high real
    interest rate of nearly 6 (Nominal 12.5) made
    its market a powerful draw for foreign investors
    starved of investment opportunities in developed
  • Brazil has been a vocal critique of the easy
    money policies of the developed countries (US and

Brazils Problems
  • Brazils finance minister, Guido Mantago, stated
    part of Brazils growth is leaking overseas due
    to the sharp appreciation of the Real against the
    Dollar making exports less competitive and
    flooding the country with cheap imports.
  • The Reals value against the US dollar jumped 48
    between July 2009 and July 2011.
  • Brazilian real soared to a 12-year high against
    USD in July 2011, strongest level since it first
    floated in 1999
  • The strength of real was further aided by the
    biggest monthly trade surplus in June 2011.

Exchange RateMonthly Average
Source Pacific exchange rate service

Brazils Problems
  • To counter the effects of rising real, Brazil
    was forced to take actions due to a surge in
    imports from China which included
  • buying dollars
  • requiring banks to hold higher reserves against
    foreign exchange reserves
  • discouraging bets on dollar weakness, and
  • tax breaks and trade barriers to protect
    manufacturers hurt by currency appreciation

Currency War
  • Brazilian actions highlight the dilemma faced by
    other fast-growing economies including Turkey,
    Chile, Colombia and Russia.
  • Central banks have been desperately trying to
    stop destabilizing capital inflows.
  • Japan launched direct intervention, a move
    contemplated by Colombia, Thailand, Singapore,
    South Korea and Taiwan.
  • China, on other hand, stuck to its long-standing
    policy of pegging renminbi to USD.

Currency War
  • The defensive position staked out by the Swiss
    National Bank on the 6th of September, 2011 is
    another indication of this growing tension.
  • The franc had overvalued by 35 in real terms
    threatening to push the Swiss economy into a very
    deep recession when the SNB took action.
  • The SNB said it would set a minimum exchange rate
    of SF1.20 against euro. (As China, fixing value.)

Currency War
  • Some Central Banks resorted to less direct action
    by resorting to slower monetary tightening than
    they would otherwise do.
  • Bank of Canada and Reserve Bank of Australia, for
    example, have taken a precautionary pause in its
    tightening cycle, not resorting to currency
    market action.

Concluding Observations
  • The current problem of hot money flows and
    currency wars is rooted in global imbalance
  • A coordinated plan by major economies is needed
    to ensure a balanced global economic growth
  • Efforts of G20 has been less than satisfactory.
  • Japans intervention in the currency markets to
    weaken the yen days before the Cannes summit of
    G20 in November 2011 is an indication of the fact
    that the G20 is either incapable or too slow to

Concluding Observations
  • Individual countries role in a coordinated policy
    action is rather demanding one.
  • What might work for one country, may not work
    well for everyone else.
  • FED fighting to prevent recession with easy money
    policy when no assistance is coming forth from
    politically paralyzed Congress.
  • European Union is hamstrung with the sovereign
    debt problems and looming recession and has not
    been able to do much to help the global recovery.

Concluding Observations
  • These recent national actions to protect their
    currencies has reawakened interest in how to
    manage destabilizing capital flows.
  • IMF suggests that the world needs rules to govern
    the imposition of capital controls.
  • At G20 meetings, there is reluctance to criticize
    China for holding down the renminbi which
    threatens developing country manufacturers with
    loss of competitiveness.

Concluding Observations
  • Lack of willingness on the part of China to
    change its exchange rate policy in spite of
    repeated threat of legislative action by the U.S.
    and the retaliatory actions taken by some by
    imposing restrictions on movements of goods and
    capital will only perpetuate the current
    environment of economic instability and market
  • What is notable about all this is that world
    organizations such as G7 and G20 have been unable
    to do much about the problem

Concluding Observations
  • Globalization that prospered during the period of
    strong performance by major economic power stands
    threatened under the current environment of
  • lagging economic growth in the west,
  • mercantilist policies of countries like China,
  • barriers to the free flow of goods and capital
    brought about by the currency war.

Current Recommendations
  • Removing dependence on U.S. dollar as a reserve
    currency has been mooted.
  • China and Russia have been vocal about their
    desire to reduce reliance on the dollar.
  • China has moved in the direction of
    renminbi-based trade settlements with some of its
  • At BRICS summit, Republic of South Africa stated
    a transition time-line unknown to mutual
    payments in national currencies to avoid USD.
  • It is difficult to visualize, however, how this
    would solve the root problem of global imbalance.

Current Recommendations
  • Two other alternatives to the reserve currency
  • Return to the gold standard, and
  • an increased role for special drawing rights
  • The second one makes more sense than the first as
    the history of the gold standard is not a
    particularly good one

Concluding Observations
  • A disturbing prediction for the world
  • unless countries join together to pursue
    coordinated policy to solve the global imbalance,
  • currency wars and trade restrictions will
  • world economy will remain unstable with continued
    financial market uncertainty and global crises.
  • What is needed is a set of prudential not
    retaliatory policies on the part of each country
    even if it is inconvenient for the moment.
  • Ultimate solution resolve the issue of global

Mahalo Aloha