Times have changed in the foreign exchange markets, says The Economist. The currencies of countries with big current-account deficits are supposed to fall compared with those of states with surpluses, thus boosting exports and curbing imports, and narrowing the gap.
But until recently, this wasn’t generally the case: the New Zealand dollar gained 28% on a trade-weighted basis between late 2002 and mid-2007, despite a deficit that reached 8% of GDP. The pound and the Icelandic krona also did well. Chalk this up to the carry trade, where yield-hungry investors borrowed in low-yielding currencies such as the yen and poured the money into countries where interest rates were relatively high, thus strengthening those currencies.
But since the credit crunch kicked in and risky carry trades have been unwound, deficits have returned to the spotlight. The weaker currencies in trade-weighted terms in 2008 have been countries with high or rising deficits: Iceland, Britain, India, South Africa and New Zealand.
So which might be next? The Polish, Hungarian and Australian currencies “seem to have been overlooked”. Australia’s current-account deficit is expected to hit around 5% in 2008, and the Aussie dollar is near a 25-year high against the greenback.