There have been some big currency moves lately, particularly in the emerging world (Argentina – I’m looking at you!). In fact, not a single emerging market currency has appreciated versus the dollar over the past six months, with the average loss being -9.4%! Turkey and Latin America have been hurt particularly bad.
Down -42%, -34%, -18%… these moves are huge, particularly for currencies. The effect this type of currency depreciation has on a country (particularly an emerging one) can’t be understated. Take Argentina for example – their currency has depreciated by -42% in the span of the last 6 months relative to the US Dollar. That means that the cost to buy goods imported into Argentina from the US has basically gone up by +42%. Can you imagine increasing the cost of a shopping trip or a big ticket purchase by nearly 50%? Its crippling to the economy.
Another effect is debt related. Many emerging countries have dollar denominated debt (where the interest and principal payments are made in US dollars). Now imagine those payments going up by 40+%. Bloomberg summarized the effects of a plummeting local currency:
“True, cheaper currencies versus the greenback aid developing economies by making their exports cheaper for foreign buyers, but the negative financial effects swamp this positive, especially as hot money departs. Servicing dollar debts takes more local currency and makes imported oil and the many other commodities that are priced in greenbacks more expensive.”
When local currency holders realize the value of their money is drastically deteriorating, capital begins fleeing the country, putting further pressure on the currency. The central bank of the affected country often will step in to stem the tide by tightening monetary policy to prevent further currency weakness, which then puts pressure on the economy… it’s a vicious cycle.
“I don’t have currency exposure… or do I?”
Just because you live in a developed economy with a stable currency doesn’t mean you’re immune to the effects of volatility in other regions. If you invest in countries where currency volatility is on the rise, there can be negative (or positive) consequences. As an example, Brazil’s stock market is up +19.1% over the past year in local currency terms. If you are a US investor and had an allocation to that market, you’d have received the +19.1% return in Brazilian Reals but because that currency has been crushed (down roughly -20%), when you covert back into US dollars, you are down -1.1%!
Of course this dynamic can have a positive outcome, i.e. when you invest in a country who’s currency has strengthened relative to your own home currency. Over a long time horizon however, these effects tend to even out. Here’s a chart of the Trade Weighted US Dollar Index going back to the 70’s.
There are ways to mitigate the effects of currency exposure in the short-to-intermediate term (i.e. currency hedging), but we’ll leave that conversation for another day.
Bottom line, there are some big currency moves happening in the emerging world. They can have nasty consequences for both the affected economies and investors with a shorter time horizon. It’s a situation worth keeping an eye on.
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