In Australia in 1983 the Hawke government introduced their most arguably important economic reform.
They floated the Australian dollar.
Floating the dollar meant the Government of the day would no longer set the exchange rate. Instead the exchange rate would be determined by the supply and demand for our currency on the international markets.
Prior to the float, the Australian Dollar was been pegged to other international currencies. First it was pegged to the British Pound, primarily because of our historical & early trading relationship with Britain. However later it was pegged to the US dollar, as the US economy became a more significant trading partner.
A fixed exchange rate is usually used to stabilise the value of a currency. It works by directly fixing the value of a local currency to a predetermined amount of a different, more stable or more commonly traded currency. A number of currencies are pegged to the US Dollar, however some smaller nations may peg their currency to the currency of their largest trading partners.
The main point of the peg is that the exchange rate between the currency and the currency it is pegged to does not change based on market conditions. This makes trade and investments between the two currency areas easier and more predictable; a very important advantage for small economies where external trade forms a large part of their GDP.
There are real questions about whether pegging a currency is worth it anymore. Movements in larger currencies are battering smaller economies, causing stress on the “little guy”.
This is best exemplified by the crisis that Malaysia faced during the 1997 Asian Financial Crisis. After a heavy devaluation of the Thai Currency, the Malaysian Government had to implement a number of costly restrictions on trading of its currency which in part led to a deep recession and forced the government to float its currency.
Earlier this year the Swiss Government allowed its currency to rise against the weak euro. This was an acknowledgment that the cost of keeping its currency on par with the weak euro was becoming a drag on the Swiss economy. While the Swiss decision occurred in a somewhat orderly manner, there are concerns that large emerging economies like Brazil will be forced to remove their pegs in a less than orderly manner, which would put a strain on developing markets and the global economy more broadly.
In fact Kazakhstan has stopped defending its exchange rate after China devalued the Yuan last week. China and Russia are Kazakhstan’s largest trading partners. Pressure on these larger economies, slowing growth in China and low oil prices, mean that the Kazakhstan Government can no longer afford to defend its currency which has now plunged 23%.
The next question is whether Vietnam will let its Dong float. Vietnam has also been concerned about its largest trading partner’s (China) recent devaluation. Rather than take the Kazakh route, they’ve allowed the Dong to trade in a wider band – for the time being.
Has the “race to the bottom” begun? With oil trading below $40US/barrel, oil producing countries like Nigeria and Egypt are under pressure. Saudi Arabia, Qatar, and the UAE may be forced to abandon their Dollar pegs too. Other ex-Soviet states like Azerbaijan, Armenia, and Georgia may be forced to follow the Kazakh example. And that’s just the oil side of the equation.
Big commodity exporters like Turkey, Brazil and South Africa will soon feel the impact of a weaker Yuan, as will other major trade partners of China. South Korea is nervous that Chinese manufactured goods may be cheaper than theirs… potentially another country to add to the list.
Overall, we can’t all have the weakest currency, nor be net exporters. Pegs have been used historically to manage economic dynamics, and more recently to shield vulnerable economies from speculators. At some point pegs may be readjusted, or go out the door, with market forces allowed to take over. However a number of the countries mentioned are not as politically stable or as robust as Australia economically. This makes the current “dual” in currencies even more important to watch.
