What Does the Strong Dollar Mean for Emerging Markets?

What Does the Strong Dollar Mean for Emerging Markets?

The popular perception is that strong/weak currencies are something of a zero-sum proposition. Yet despite the gloomy prophecies of many emerging market specialists from 2016, the strong dollar hasn’t hurt these developing economies. Rather, geopolitical turmoil was more of a factor  than currency strength/weakness. Additionally, different markets reacted differently to a strong dollar–and the notion of a one-size-fits-all outlook is false.

What is currency strength–and how does it affect economies?

Currencies are often measured against each other. On one hand, a strong currency leads to increased consumption and international travel: if your dollar is strong, then its purchasing power is higher relative to other currencies. This makes it easier for you to go overseas and visit other countries, or, if you’re an investor, to buy stock in foreign companies, as your money will go further.

The flip side of that is currency flight and decreased exports. Many of these investors will take their money and go overseas, as they can get more bang for their buck. Additionally, foreign investors would likely stay away from American companies; because their purchasing power is more limited than the dollar, their money simply wouldn’t go as far.

In this sense, a weak currency is better for emerging markets: it can attract foreign investors seeking to maximize returns, making it cheaper for them to set up crucial factories and other developments. Devaluing domestic currency to boost foreign direct investment (FDI) was a strategy followed by a number of countries, from Vietnam to India.

Have predictions come true?

In 2016, there were a host of editorials and pundits arguing that, for all their seeming strength, emerging markets were uniquely susceptible to the strong United States dollar. Part of this concern stemmed from an accompanying hike in Federal Reserve interest rates (standard procedure in times of currency strength), but there were other factors in play. Chief among these was melt: in essence, many emerging markets (Turkey, Mexico, and Indonesia among them) hold their debts in American dollars; rising dollar strength means that repaying such debt becomes more expensive as a rapidly growing dollar leaves domestic currencies behind.

Yet these predictions have not come to pass, for the most part; even in cases where an emerging market has slowed, we can likely attribute that more to a complex confluence of geopolitics and domestic events, rather than the strong dollar alone. In South Africa, for instance, political infighting and corruption led to a downgrade of the nation’s credit rating–to junk.

Yet Turkey may provide the most salient example. As I wrote in a previous entry, the nation has been wracked by poor political leadership, regional instability, and the increasingly authoritarian approach of President Recep Tayyip Erdogan. Within the past year alone, Turkey has faced threats in the form of ISIS and Kurdish separatists and undergone a (nearly successful) coup attempt. Erdogan responded by consolidating power and stifling free press and business, pushing out thousands of Turkish citizens (including its richest and most talented), and slowing the once thriving economy.

Clearly, the causes of Turkish economic strife are multifaceted and complex. Yet in Mexico, despite all predictions to the contrary, as well as clear antagonism form the Trump administration (remember the promises of a border wall and tariffs?), the Mexican currency has rallied 10 percent, becoming one of the highest performing currencies worldwide in the Trump era. Despite an initial overreaction, Mexico’s peso strengthened as economic realities cooled hot rhetoric, coupled with a series of embarrassing, high-profile gaffes for the Trump administration.

Further, not all currencies (and economies) remain equal. Those nations with robust, highly-developed domestic markets (such as China, India, and Indonesia) are far less likely to succumb to a stronger dollar. After all, these nations can simply rely on domestic consumers to make up the shortfall. In China, for instance, a massive, fast-growing middle class (along with North American consumers and the elderly in developed countries) is forecasted to generate half the projected growth in consumer spending. Barring anything short of a trade war, it’s hard to see how the dollar can set back a developing nation with a strong internal economy.

Will domestic developments weaken the dollar?

Still, as strong as the dollar may have been, this may not last. Shortly after Trump’s election, the dollar was the strongest it had been since 1986, rising an unprecedented 25% against other currencies since mid-2014. This was due to a confluence of factors, from increasing weakness of the euro, a result of instability in the European Union, as well as slowdowns in other global stock markets and currencies.

Yet this unprecedented strength may soon be ending. Soon after his inauguration, President Donald Trump expressed a desire for a weaker dollar; in essence, Trump’s desired goals (increased competitiveness on the global market and an aim towards attracting investment) are incompatible with a strong dollar. To no one’s surprise, not long after Trump made his comments, the dollar sank drastically, dropping 0.7%.

Even though American presidents traditionally refrained from talking about currency strength (for fear of adverse effects), Trump’s message may not be as consistent as it initially seems. Conflicting signals from the Trump administration (over NAFTA, border taxes, and the like) seem to indicate that rather than weakening the dollar, the US government may yet continue with the strong dollar policy in place for the past several decades. The dollar would certainly continue to rise if global investors take advantage of higher interest rates and bring their assets to the United States.

Ultimately, it’s too simplistic (and inaccurate) to say that a strong dollar will tank emerging markets. The term is simply too broad, encompassing nations in the middle of geopolitical turmoil (Turkey) to those with highly developed internal economies (China). Further, no one is clear whether a weaker dollar is simply political rhetoric–or an indicator of a new economic reality under Trump.

2017-07-06T21:12:53+00:00 July 6th, 2017|Emerging Markets, Finance, Global Markets|0 Comments

Leave A Comment