In September 2010 Brazil’s finance minister, Guido Mantega, accused developed countries of waging "a currency war" against developing countries. The backdrop to this claim was the strength of the Brazilian exchange rate which, Mantega alleged, was caused by aggressive monetary policy in the developed nations. In particular, the policy of "quantitative easing" in the US was causing large capital inflows into developing countries. This meant their exports were made uncompetitive by overvalued exchange rates. In contrast, the exports of developed nations benefited from weak exchange rates.
Mantega’s claims were echoed in South Africa where the rand’s strength was blamed for sluggish recovery from the economic downturn that started in 2008. Exporters in business and the trade unions joined hands in calling for the Reserve Bank to intervene to weaken the rand. This sentiment found support in the New Growth Path approved by Cabinet in October 2010. It committed South Africa to "additional and larger purchases of foreign currency … to counter appreciation of the rand as required".
Were claims of a currency "war" justified? Certainly, the aggressively stimulatory monetary policies in the US and other developed countries pushed up exchange rates in developing countries. But it is questionable that this was the intention. Historically low interest rates and quantitative easing in developed countries were meant to stimulate their own consumer spending and investment through increased bank lending.
In this way policy makers hoped to engineer recovery from the deep recession caused by the 2008 financial crisis.
But the economist John Maynard Keynes famously said that stimulatory monetary policy may be "like pushing on a string". Central banks can lower interest rates, but they cannot force households or businesses to borrow. Nor can they force banks to lend to customers whose creditworthiness is in doubt.
And so, even though interest rates were cut to historic lows, bank lending growth was slow. Instead, the created liquidity in financial markets flowed overseas — including to developing countries whose interest rates were comparatively high. This caused excessive exchange rate strength, jeopardising developing countries’ efforts to grow.
The strength of the Brazilian and South African currencies was therefore because monetary policy failed to achieve its goal of stimulating bank lending within developed countries, rather than deliberate currency manipulation. But this was little comfort to exporters in developing countries battling strong currencies and weak global markets.
South Africa and Brazil’s exchange rates have weakened by about 25% since the middle of 2011. Falling global commodity prices caused this fall, as did sluggish economic growth in both countries. With the US finally showing signs of recovering from recession, weak growth made both SA and Brazil less attractive to investors. Global currency swings have begun again and the issue of overvalued currencies has recently resurfaced — but this time mainly in developed countries.
Aggressive monetary expansion in Japan, where the central bank is determined to drive economic recovery after decades of stagnation, has created even larger amounts of financial liquidity. And again, much of it has flowed overseas. The yen has weakened as a consequence. Last week it was valued at more than ¥100 to the dollar for the first time in nearly five years.
Central banks in a number of countries have moved to counter the effect on their currencies. Last week the central bank of China bought dollars to counter their exchange rate strength, continuing a long history of intervention during which China has accumulated almost $3.5-trillion of reserves. More surprisingly, the Reserve Bank of New Zealand — which historically never intervenes in the currency market — confirmed that it too had bought reserves to push its currency lower.
Last week Sweden’s finance minister warned that exchange rate strength was a problem. Then Australia cut its interest rates. As with the European Central Bank, which cut rates to a new historic low this month, this was designed to stimulate flagging domestic demand. But in Australia’s case the government has made it clear that currency strength is a problem and is causing extreme economic weakness outside of the mining sector.
Neither the rand nor the Brazilian real has strengthened during this recent period of increased global liquidity. This is a bitter-sweet outcome. It shows that even at a time of great financial liquidity, investors find our weakly growing economies an unattractive proposition. In South Africa, a further concern for investors is possible production losses during the upcoming mine wage negotiations.
That our manufacturing exports remain weak, despite an already much weaker rand, is also worrying. Local manufacturers struggle to compete globally because South African production costs keep rising faster than those of our competitors. The rand may need to weaken further before exports can grow.
In the meantime, the current global environment of lower interest rates creates an opportunity for the Reserve Bank to cut our interest rates still further. This is unlikely to push inflation higher given the weakness of domestic demand. It may provide a modest and timely boost to our currently feeble economic growth.
Written by: Gavin Keeton
• Keeton is with the economics department at Rhodes University. This article was published on Business Day.