Don’t get excited over ‘strong’ peso

BSP Governor Paeng Buenaventura said it right: The exchange rate is important in so far as it relates to our competitiveness in the world market. A "strong" peso by itself is not a sign of economic health. It could result in a loss of competitiveness vis-a-vis the other countries in the region. Paeng wants the peso to be stable and if it has to move, move with the other currencies, like the Thai baht.

Yet, some politicians couldn’t help getting excited. The peso went below the P50 to $1 mark for the first time in a long while. According to news reports, President GMA claimed credit for the strength of the peso. I suspect she was misquoted because as an economist, she knows it is a whole lot more complex than that. Besides, the peso isn’t really that strong yet. It stumbled a bit after a couple of days of "strength" and is still a couple of pesos away from its old gap with the Thai baht.

It is true that Ate Glo’s stewardship of the economy is starting to bear fruit. And we may not have been able to take advantage of any positive development in the world market if we had serious unattended problems of our own. But the movement in the exchange rate in recent days is more likely a result of the weakening of the dollar against the world’s major currencies, more than anything else.

I understand that currency traders decided to play with the dollar following a statement from the US Treasury Secretary in response to demands for intervention, that he would not intervene in the currency market. US businesses are up in arms over the strong dollar. They say it is slowing down their ability to sell abroad. As usual, the currency traders are testing the Treasury Secretary’s resolve.

It does not help that the dollar is really terribly overvalued on account of America’s large current account deficit. America has been importing far more than it has been exporting for years, The Economist pointed out, financed by foreigners attracted by tantalizing equity returns.

The IMF, no less, says that this deficit is the biggest risk to the world economy today. A current account deficit can only be financed by capital inflows, by borrowing from foreigners or selling assets to foreigners. The Economist estimates that this deficit "will require America to borrow from abroad almost $2 billion a day by 2003."

It also does not help that President Bush’s war on terrorism and the resulting massive military build-up plus his tax cuts have turned Clinton’s budget surplus into a fairly large deficit. An economy that isn’t as strong as America’s would have buckled over some time ago. For so long as foreigners keep on investing in America, the current account deficit is, as US Treasury Secretary Paul O’Neill puts it, "a meaningless concept."

Big Mac index

How overvalued is the dollar? The Economist offers its Big Mac index as a useful measure. Devised 16 years ago, The Economist described the Big Mac index "as a light-hearted guide to whether currencies are at their ‘correct’ level." The index is based on the theory of purchasing-power parity (PPP). "In the long run, countries’ exchange rates should move toward rates that would equalize the prices of an identical basket of goods and services. Our basket is a McDonald’s Big Mac, produced in 120 countries."

Under this concept, the Big Mac PPP is the exchange rate that would leave hamburgers costing the same in America as elsewhere. A currency is under-or overvalued depending on how the Big Mac PPP compares with the actual dollar exchange rate.

The Philippine peso is 49-percent undervalued, using the Big Mac index. Given a general weakening of the dollar and the absence of any serious drag to the peso, it simply had to go up. To be more accurate, the peso most likely didn’t appreciate as much as the dollar depreciated.

Going back to the Big Mac index, The Economist concludes that "overall, the dollar now looks more overvalued against the average of the other big currencies than at any time in the life of the Big Mac index. Most emerging-market currencies also look cheap against the dollar. Over half the emerging-market currencies are more than 30-percent undervalued."

How reliable is this Big Mac index? The Economist claims that "in the early 1990s the Big Mac index repeatedly signaled that the dollar was undervalued, yet it continued to slide for several years until it flipped around." What happens next? The Economist says that based on the Big Mac index, their "latest figures suggest that, sooner or later, the mighty dollar will tumble."

I suppose we have to watch investor confidence closely. As it is, analysts think the current dollar weakness was also sparked by investor concerns that among others, the good news in US first quarter GDP growth of 5.8 percent is not sustainable. Corporate profits remain anemic. The unemployment rate is not showing any sign of relief. Investor confidence is also down because of all the scandals related to corporate governance, as well as those large write-offs by AOL and other blue chips.

There is also historical evidence, according to The Economist, that large current accounts deficit always collapse in the end. The adjustment that follows "was typically accompanied by an average fall in the nominal exchange rate of 40 percent, along with a sharp slowdown in GDP growth."

For now at least, it is still obvious that warts and all, America still offers the best investment opportunities around and foreigners will still fund the current account deficit. But, the IMF warns, "if flows of capital to America begin to dry up, the deficit will have to shrink, either through a decline in domestic demand or a fall in the dollar or both."

That’s the really scary side of what’s going on now. Our economist by the Pasig knows this is something to worry about. Do I hear any more cheers for the "strong" peso and eager claims for bringing it about?

What a difference

Reader Fe dela Cruz sighs, what a difference 30 years make.

1972: Long hair; 2002: Longing for hair

1972: The perfect high; 2002: The perfect high yield mutual fund

1972: KEG; 2002: EKG

1972: Acid rock; 2002: Acid reflux

1972: Growing pot; 2002: Growing pot belly

1972: Seeds and stems; 2002: Roughage

1972: Popping pills, smoking joints; 2002: Popping joints

1972: Hoping for a BMW; 2002: Hoping for a BM

1972: Going to a new, hip joint; 2002: Receiving a new hip joint

1972: Rolling Stones; 2002: Kidney Stones

1972: Parents begging you to get your hair cut; 2002: Children begging you to get their heads shaved

1972: Taking acid; 2002: Taking antacid

(Boo Chanco’s e-mail address is [email protected])