You've read about Brazilian Finance Minister Guido Mantega's declaration last week that the world is in a "currency war." Here's what the onslaught looks like from Mr. Mantega's perspective:
Net private flows to emerging market economies will surge to $825-billion (U.S.) this year, compared with $581.4-billion in 2009 and $594.4-billion in 2008, according to the Institute of International Finance said Monday in revised estimates. That's a 42-per-cent surge from last year and a 16 per cent jump from the $709-billion in the IIF's 2010 forecast in April.
The estimate shows the magnitude of international funds rushing into countries such as Brazil, China and India, putting on pressure on the currencies needed to purchase assets in those countries. The big revision from April suggests this phenomenon picked up speed through the middle part of the year as investors gained confidence that emerging markets could flourish without strong growth in the U.S. and other developed economies. (For more on that, check out this Bloomberg story)
"The persistent strength in private capital inflows raises new headaches for emerging market policy makers," the IIF said in its report, citing in particular the upward pressure on exchange rates.
International investors are being driven by a combination of "push" and "pull" factors. Low nominal interest rates in the U.S., Europe and Japan and weak economic growth are pushing investors look elsewhere for yield. At the same time, these investors are being pulled to Asian and Latin America by higher interest rates in countries such as Brazil and India and strong economic growth.
Some emerging markets can stand currency appreciation, the IIF said, singling out China. "Yuan real appreciation would be one important mechanism through which necessary global rebalancing could take place, although not the only one."
Still, the IIF prefers that adjustments of this kind take place at a moderate pace, and preferably through an agreement of complimentary policies arranged through a compact of a core group of countries. At a press conference Monday, Charles Dallara, the IIF's managing director, called on the United States, China, Japan and leaders from the euro zone to agree to modern-day version of the Plaza Accord.
"The near-term danger," the IIF said in its report, "is that this upward pressure escalates and market adjustment becomes disorderly, causing renewed strains in global financial markets and, possibly, igniting policy tensions and, possibly, protectionist measures between key economies (most obviously the U.S. and China)." The report adds that "policy makers thus need to keep an eye on the international, in addition to purely domestic, implications of the actions they take. For the Federal Reserve, for example, this means evaluating the costs and benefits of further quantitative easing from a global as well as domestic perspective."