Brazil’s Currency Wars – A “real” problem

By - 11 October, 2010

The last thing the global economic recovery needs right now is instability. But this is precisely what central government manipulation of currencies is likely to lead to. According to Brazil’s finance minister, Guido Mantega, the world is in the midst of an “international currency war” as some governments have forced down the value of their currencies in order to remain competitive. A currency war could result in high volatility in the foreign exchange market or retaliatory protectionism, as countries try to boost exports at the expense of others, putting international trade at risk and destabilising the recovery.

Many countries, notably China, have been deliberately weakening their currencies by selling them on foreign exchange markets or keeping interest rates artificially low to make their exports cheaper and therefore more attractive to overseas investors. However, since the financial crisis, many economies have attempted to use currency depreciation as a means to grow themselves out of recession.

However, this is leading to global imbalances on the foreign exchange markets and many emerging economies, such as Brazil, are using increasingly desperate measures to hold down their currencies. The Brazilian authorities have intervened in the currency market to stifle the appreciation of the real – treading the same path as Japan with their own currencies – whose appreciation threatens the competitiveness of their exports. Brazil recently doubled taxes on capital inflows, but this has failed to halt the sharp appreciation of the real, and has done little to slow down foreign investment.

These imbalances are in large part to do with the struggling western economies of the US and Europe, the outlook of the US economy remains highly uncertain and as a result the dollar has weakened. In these economies interest rates remain ultra-low, resulting in investors searching for higher returns, mainly in emerging markets – of which Brazil leads the crowd.

Although in the short-run individual economies, such as Brazil, try and hold down their currencies, economists fear that such moves are resulting in increasing volatility and instability. Imports jumped 38.8 percent from a year ago, five times the 7.3 percent increase in exports, as consumers took advantage of a strong currency to travel and increase purchases abroad.

It is perhaps even more worrying that amid fears of a renewed slowdown, getting the global economy on track will prove even harder to tackle without a fully committed and co-ordinated policy response from all major economies.

Brazil’s economy is booming following economic reform, growing at an annualised rate of 8.9 per cent in the first half of 2010. Foreign investors and currency speculators (especially those in the carry trade) have flocked to the country because of high interest rates which are currently 10.75 per cent. New investment opportunities such as the offering of state-controlled company Petrobras ($67bn) continue to bring in additional investment. According to investment bank Goldman Sachs, its currency is the most overvalued major currency in the world.

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