Refugees of the Currency War, Unite!

Today’s global currency war resembles real war in two important respects: a face-off over the structural imbalances between two large opponents – China and the United States – has forced uncomfortable smaller allies to take one side or the other, and third parties that may not be directly engaged are suffering collateral damage from both sides of the dispute.

Latin America’s rapidly growing economies are particularly vulnerable, as they are forced to confront both China’s exchange-rate inflexibility and the impact of dollar devaluation arising from the US Federal Reserve’s expansionary monetary policy.

The mechanics are familiar: dollar liquidity flees to emerging countries in search of higher yields, putting upward pressure on their currencies. Brazil, Chile, and Colombia, among others, are now confronting these powerful forces of currency appreciation. This pressure is compounded in resource-rich Latin American countries by the increase in commodity prices caused by a similar search for yield and by the fall in the dollar’s value.

But why should Latin American countries care about these capital flows and the revaluation of their currencies? After all, capital inflows traditionally have been regarded as a positive transfer of savings from rich industrial countries to capital-scarce emerging markets.

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