World Currency Markets and the Financial Bailout/Rescue Package
There are times when it pays to be the world’s leading economy. The U.S. housing collapse and credit crunch have initiated a slowdown that has become readily apparent through job losses and weaker consumer spending. This new reality and the worsening prospect for product demand and profitability has driven down stock prices.

The U.S. slowdown and problems in the financial sector have spread around the world. The U.S. financial bailout/rescue package suffers from uncertainty about its implementation policies and likely degree of success. However, it is still seen as a first step in the right direction and a better answer to the gathering gloom than the lack-of-action being taken by many other countries.

Greenback’s Traditional Role as a Safe Haven
For example, central banks in Europe are now being perceived as responding too slowly and in an uncoordinated fashion to failing and at-risk banks in their own backyards. Hence, there is a stampede underway by international currency traders to place funds in “safe” securities such as U.S. treasury bills and bonds. The greenback has traditionally been the number one haven for investors in difficult economic times. The luster of the greenback may be tarnished, but it is still proving more attractive than the alternatives.

Commodity Prices Damaged by Two Factors
The global economic slowdown has dampened the prospects for commodity demand. Furthermore, the climb in value of the U.S. dollar is an additional factor in the lowering of the price of commodities. Commodity prices and the value of the U.S. dollar have been moving in an inverse relationship for the past several years (i.e., when one increases, the other falls and vice versa).

In addition, the financial crisis has led to margin calls on hedge funds and leveraged accounts that bet heavily on ongoing strength in raw materials demand. The overall result is that commodity prices are tumbling and this is affecting the currencies of countries that are particularly dependent on export sales of their natural resources.  

Currencies of Commodity-based Countries are Struggling
This includes Canada, where the loonie is back down to around $0.90 USD, after exceeding parity during much of the past year. Russia, Brazil and Australia are other nations that are being slammed by the commodity price slap-down. Declines in stock market values in North America have undoubtedly been heavy, but they have been less severe than what has happened in some other countries.

Not all commodities and currencies are in freefall. The price of gold ($866 USD yesterday) is marching back upwards due to its role as a wealth repository in times of extreme financial uncertainty. Also, the Swiss franc (over the past few days) and Japanese yen are proving relatively resilient.

Scorecard on Countries with Declining Currencies versus the U.S. Dollar

The following looks at countries where the value of the currency has been falling versus the U.S. dollar since the beginning of this year.

Britain − a weakening economy, moderate-to-high inflation (+4.7%), high interest rates (6.25% for three months) and substantial trade and government deficits. There have also been serious problems in the financial sector that have required government bailouts. The pound is suffering in a comparison with the U.S. dollar.

Euro-based Europe − a weakening economy, moderate inflation (+3.8%) and relatively high interest rates (5.07%). Germany has a larger merchandise trade surplus than China. Bank sector bailouts are hitting Europe with a delayed reaction versus the United States. An increase in government debt positions will hurt the value of the Euro.

Brazil − a commodity base and strong growth, high inflation (6.2%), a good trade surplus and high interest rates (13.66%). All of the other major countries of South America (Argentina, Chile, Colombia and Venezuela) also have nearly double-digit interest rates or higher as a result of rapid price inflation.

Australia − a commodity base, moderate growth, moderate inflation (+4.5%), a trade deficit and relatively high interest rates (7.42%). The Australian dollar has taken a particular nosedive of late.

Currencies Staying Even with the U.S. Dollar or Making Gains
The following looks at countries where the value of the currency has been staying even with the greenback or rising in value.

Mexico − economic growth and inflation are about the same as in the U.S., but the country’s merchandise trade position is in balance and interest rates are much higher (8.15%). Low labor rates and proximity to the U.S. will continue to support this country as it strives for greater prosperity.

Japan − weak growth, minimal inflation (+2.3%), a large trade surplus, non-existent interest rates (0.75%) and a large government deficit. The Japanese government wrung up huge debt several years ago when it embarked on a massive infrastructure program to stimulate the economy. That effort proved to be ineffective as consumers continued to hoard cash.

China − exceptional growth, borderline-troubling inflation (+4.9%), a large trade surplus and moderate interest rates (4.31%). State-ownership of firms has meant a huge build-up of foreign exchange reserves, which will help China to fund domestic growth as the rest of the world falters. The value of the Yuan has increased about 20% versus the U.S. dollar since a partial float was allowed beginning in July 2005.

Some other Regional Economies

Some other observations on regional economies are warranted, beginning with Southeast Asia. Hong Kong, Singapore, South Korea, Taiwan and Thailand are all expected to grow at a good pace in 2008 (+4.0% or higher), with some softening in real GDP growth coming in 2009. Only Indonesia has an inflation rate (+11.8%) that is bordering on out-of-control.

Russia is achieving good growth, but its inflation rate (+14.7%) is also extraordinary. The country has the good fortune to be recording a large trade surplus which is also helping with government finances, since most of the nation’s largest resource companies are state-owned. It has been the resource companies that have racked up the net export gains.

Those same resource companies have also been agents of Russia’s aggressive and provocative political dealings with its neighbors. Given the collapse in the Russian stock market, those actions may have to be reined in if Russia is to retain needed foreign investment.

Implications for Canada and Construction

The “emerging nation” effect will help to shore up demand for Canada’s raw materials. In turn, this may help to establish a floor for how low the loonie can fall. According to most criteria − low inflation, a merchandise trade surplus and healthy government balance sheets − Canada’s yardsticks are better than those of the U.S.

The recent drop in value of the Canadian dollar has also come at a propitious time for Canadian manufacturers. As they face the prospect of reduced demand for their products from south of the border, they are getting a break in the form of an opportunity to offer lower prices.

As for investment in resource projects in Canada, the international price of oil has dropped below $90 USD per barrel and this will raise questions about development activity in Alberta, Saskatchewan and the offshore Atlantic. In mining, high-cost producers will be mothballing sites and riskier new investments will come under review. The prognosis for investment spending in the resource sector has suffered a setback.

There is one significant benefit for the construction industry. Almost all construction materials are commodity-based − think iron ore and coal in steel production; oil and natural gas in asphalt, paint and insulating materials; copper in wiring and plumbing fixtures. The retreat in commodity prices that is currently underway will help to reduce the volatility in construction costs for the rest of this year and most of 2009 as well.

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