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'Don't expect fireworks' on currency wars

By Phil Thornton
15 Mar 2013

Latin American responses to Western efforts to devalue currencies spread beyond the 'usual suspects'

Latin America risks being caught in the crossfire of the currency war that is building up within the G10 group of rich countries, leading economists have warned.

Latin American complaints about currency wars had spread beyond the “usual suspects,” according to a top expert on economic protectionism.

Simon Evenett, a professor at the University of St Gallen, Switzerland, and co-founder of the independent trade protectionism monitor Global Trade Alert, said Chile, Colombia, and Mexico had joined Brazil and Argentina in complaints about QE by the rich nations.

“What scares policymakers is the threat of growing macroeconomic imbalances,” he said. “Quantitative easing induces hot money to surge into Latin America, first destabilizing national financial markets and then spilling over into the real economy.”

Currency wars have risen up the political agenda this year since Japan announced it would buy potentially unlimited volumes of government bonds and widen its inflation target to allow prices to rise by 2% a year instead of 1% as part of a strategy to weaken the overvalued yen.

This triggered an angry response from German central bank chief Jens Weidman, who condemned the “increased politicization of the exchange rate”.

But the response from Latin America is likely to be more nuanced.

“Japanese QE adds fuel to the fire as more money seeks higher yields in emerging markets,” Evenett said. “Even so, don’t expect fireworks at the IDB meeting: resentment may grow but the QE protagonists are counting on the Latins to adjust.”

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Faced with strong capital inflows thanks to the continued provision of liquidity by rich countries’ central banks desperate to fight the threat of recession, policymakers in emerging markets are battling to stop their currencies from appreciating.

“Efforts to promote currency weakness to protect competiveness are found in a mix of interest rate cuts, foreign exchange purchases and macroprudential measures, with varied impacts on each country,” said Ian Stannard at Morgan Stanley.

The escalation of tension comes three years after Brazil’s finance minister Guido Mantega coined the phrase “currency war” in response to quantitative easing (QE) by the US Federal Reserve that he said was a tool to devalue the dollar.

Colombia has cut interest rates six times since June and concerns about the currency war were also seen as a factor in the U-turn by the Banco de Mexico away from a hawkish stance to its decision this month to cut rates for the first time in nearly four years.

In an unorthodox twist to the usual currency intervention, Peru this year announced that it would buy back its international bonds and issue ones denominated in its domestic currency instead.

Luis Oganes, chief Latin America economist at JP Morgan, said it was clear that currency appreciation was a growing concern among policymakers across the continent, despite their apparent calm on the issue. “Even though we may not hear more talk about currency wars, that does not mean Latin American policymakers are going to sit tight and do nothing about the currency appreciation pressures they will all be facing,” he said.

The one country that may not take part is, ironically, Brazil – where climbing inflation expectations have forced policymakers to take a pause in the currency war and change their bias towards a stronger real.


- Like every year, Emerging Markets daily newspaper covers the Inter-American Development Bank’s annual meeting, held in Panama in mid-March. Pick up your copy at the meeting, read the news on our website and follow us on twitter @emrgingmarkets

By Phil Thornton
15 Mar 2013
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