Fundamental Analysis – Emerging Markets and the U.S. Dollar

The U.S. dollar is the most important currency in the world at this very moment. It is the world’s reserve currency, and this comes as a tremendous privilege for the United States economy. Such a privilege allows the United States to run a huge deficit because the dollar is the one that denominates foreign transactions. Oil, for example, is sold in dollars. The United States through its foreign policy used its influence for oil to be sold in dollars by the Middle East countries, mostly OPEC (Organization of Petroleum Exporting Countries) in turn off protection in the region. Moreover, the proceeds from such transactions were directed in buying US Treasuries (government bonds). A process like this allowed the United States to run such a big deficit as it was/still is funding it ongoing. The Federal Reserve’s role became to simply make sure the dollar is priced in accordingly. Being the world’s reserve currency comes with some risks too. The United States economy is the first one to react when unpredictable shocks are coming. Before the U.S. dollar, the Great Britain pound was the world reserve currency. Gold has been used in time to back the money in circulation, but nowadays there is only the fiat money concept in place. The Bretton Woods conference, named after the forest that was surrounding the hotel in the United States where the conference took place, sealed the place of the dollar as a world’s reserve currency and confirmed the United States economic dominance. During those years, Europe was in a terrible shape as war left tremendous disruptions.

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The Dollar’s Role in Emerging Markets Economies

An emerging market is defined as a country that has some characteristics of a developed market but doesn’t have all its standards. Emerging market economies, therefore, are trying to catch up with the front group and, in doing that, they borrow money. This money is used either to finance their own deficit or to develop much-needed projects in infrastructure and all. The problem comes from the fact that these loans have to be repaid. The dollar being the world’s reserve currency, the loans are in dollars. Either the World Bank or other institutions broker a loan for a country at a specific rate level and for a specific project. If the interest rate in the United States is rising, the dollars to be paid back are becoming more expensive. This is suddenly a burden for the emerging market countries that borrowed when the interest rate on the dollar was low and has to pay interest and principle on a stronger dollar. This gives the United States a negotiating privilege with the countries in this situation. All this, just because the dollar is the world’s reserve currency.

Defining an Emerging Market

In 2010 a new report by a Spanish bank, the BBVA, made it easier to identify an emerging market. Based on a specific set of conditions that are met or not, countries are divided into eagles, nest, and other emerging markets. Brazil, China, India, Russia, Turkey, Indonesia, and Mexico are in the first category. They are considered eagles, meaning that their GDP (Gross Domestic Product) in the next ten years is expected to be larger than the average GDP of the G7 economies. That is, except the United States economy. In the nest category, countries are expected to have the GDP lower than the average of the G6 economies (G7 minus the United State. However, it must be bigger than Italy’s. Countries in this category are Nigeria, Peru, Saudi Arabia, Poland, and the list can go on. The last category is formed out of countries like Romania, Estonia, United Arab Emirates, and so on. As it can be seen, countries members of the European Union (e.g. Romania) or even in the Eurozone (e.g. Estonia) are in the emerging markets category. In other words, an emerging market is one that is striving to be a developed one. It is not mandatory for emerging markets to stay like this forever. Also, developed countries can fall in the category of emerging markets. What is the deal with being an emerging market country or not?
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Strong Economic Demand

Emerging markets are characterized by a strong economic demand. Supply and demand cannot be satisfied by internal forces, so these countries have, most of the times, a deficit. This means that exports are smaller than imports. To finance this deficit, they need to borrow money, and these loans are in dollars, as explained earlier in the article. One should think that a country has expenses and incomes. If there is more money spent than earned, a deficit appears. At the end of the say, money to cover the deficit are needed on a monthly or yearly basis, sometimes even on a shorter period of times. Therefore, everything that is happening with the dollar, affects these countries. All emerging markets countries have their own central bank, but there is not much to be done when the United States is changing the monetary policy. In fact, many emerging markets countries, like Turkey, tried to manipulate their currency to prevent inflation from affecting their economies. Rarely this works in the long run because the dollar’s policy is more important for emerging market’s creditors. For Forex traders that are trading emerging market’s currencies, knowing what and when the Fed is moving on rates or is changing the monetary policy is key. The funny thing is that the countries in the emerging markets category are the most populated ones. Strong demand for various products is expected from emerging markets, and from developed ones. Imagine only China, Brazil and India, sum up the population number and you have an idea about how true demand is looking like. Being able to satisfy such a large number is not possible these days. In the world of finance, and not only, it is all about money and influence. How much influence can the dollar buy, and how much is the cost emerging markets have to pay when the interest rate on the world’s reserve currency, the dollar, is changing.

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