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April 19, 2016

A strong US dollar, who is paying the price?

The Canadian Charger

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It appears that the current strong U.S. Dollar policy, resulting in an economic downturn in developing nations like Egypt, is not the first time the world has witnessed this scenario.

During the early 1980s, U.S. high-interest rate policy (the ‘Volker shock’), resulted in Malaysia becoming but one example of a country whose economy plummeted in the wake of the strong U.S. dollar policy.

In 1981, the 'Volcker Shock,' - named after then U.S. Federal Reserve Chairman Paul Volcker - raised interest on all U.S. loans to a debilitating 21%.

Between 1980 and 1985 the dollar had appreciated by about 50 per cent against the Japanese yen, Deutsche Mark, French Franc and British pound, the currencies of the next four biggest economies at the time.

The economic downturn in developed countries triggered by the U.S. high-interest rate policy in the early 1980s resulted in a massive collapse of world commodity trade.

While the people in developed countries felt the pain, it was the developing nations – those that could least afford it – that were hit the hardest.

As Naomi Klein explained in her book The Shock Therapy, developing countries that had had their feet swept out from under them in the 70's (their main industries privatized, protections removed through free trade and foreign pressure) were now in even less of a position to resist international pressure.

Government leaders simply had no choice but to privatize under the massive debt and pressure from international powerhouses like the IMF.

Witness the fate of Malaysia, a country that instituted policies to protect its economy from foreign pressure to “privatize”, which, for the most part, means to sell their companies to foreign multinational corporations.

Malaysia's New Economic Policy (NEP), launched in 1971, marked the beginning of a new era of macroeconomic activism.

In November 1980, the Minister of Trade and Industry, Dr Mahathir Mohamad (who became Prime Minister a year later), announced a state-sponsored heavy industry project with the stated objective of “strengthening the foundation of the manufacturing sector”.

In November 1980, the Heavy Industries Corporation of Malaysia (HICOM), a public-sector holding company was incorporated to implement the new policy.

HICOM’s mission was to establish industries in areas such as petrochemicals, iron and steel, cement, paper and paper products, machinery and equipment, general engineering, transport equipment, and building materials. It also included a number of energy-related projects, including Petronas’s production facilities for the processing and export of natural gas.

But the strong U.S. Dollar policy which led to falling commodity prices made these plans obsolete.

An October 2010 research paper entitled Malaysian Economy in Three Crisis, by Prema-chandra Athukorala, at the Australian National University states that between 1984 and 1986, Malaysia’s overall export price index declined by 30 per cent, reflecting a sharp decline in tin and palm oil prices.

Needless to say, this decline in export prices led to an economic downturn, which caused problems for the new industries, most of which had just begun production.

In his research paper, Dr. Athukorala said HICOM suffered a total operation loss of US$100 million in 1986/87, an increase of 71 per cent over the previous year.

In addition to these losses, there was also a drain on the government's finances resulting from the additional debt repayment burden of these firms associated with the depreciation the Malaysian Ringget against foreign currencies.

At the end of 1988, 37 per cent (or US$6.1 billion) of total public sector debt of US$16.7 billion) was attributable to public enterprise loans, which were, of course, in U.S. dollars.

Meanwhile, the sharp contraction in the economy, increased unemployment and created a banking crisis:

“During 1980-84 the average annual growth rate was 7 per cent, and in 1985 it was – 1 per cent and in 1986 1.2 per cent. On the general business front, the sharp downturn in aggregate demand created massive excess capacities and a rising number of corporate bankruptcies. The unemployment rate increased to 8 per cent in 1986 from an average level of 4.5 per cent during the first half of the decade. The recession also precipitated a severe banking crisis, with the non-performing loan (NPL) ratio of commercial banks reaching a historical height of 30 per cent in 1987 and 1988,” Dr. Athukorala said in his research paper.

In response to the crisis, the Malaysian government abandoned its policy of trying to protect Malaysian industries. Private sector managers – mostly executives of foreign joint-venture partners, replaced Malaysian government bureaucrats.

There was also a new emphasis on promoting Foreign Direct Investment (FDI) in the economy. An amendment to The Investment Coordination Act, in 1975 allowed foreign investors to own 100 per cent of new projects that exported most of its products or sold its products to firms in FTZs that employed at least 350 full-time Malay workers. FTZs are a specific class of special economic zones. They are a geographic area where goods may be landed, handled, manufactured or reconfigured, and reexported without the intervention of the customs authorities.

As a result of these changes, the investment climate for private investment improved - in particular FDI – while total investment started rising from 1986. In the wake of these new economic policies, the current account went into surplus in 1987, and the budget deficit was down to about five per cent by 1988, from the average level of 13 per cent in the first half of the decade. While this benefited foreign investors in particular, Malaysia's public debt continued into the 1990's.

Fast forward to March 24, 2016 to find an article on Reuters website entitled “EMERGING MARKETS-Latam currencies fall on commodities slump, U.S. rate hike speculation” by Bruno Federowski.

“Higher U.S. rates could draw funds away from emerging markets, which now benefit from a wide interest rate spread. A stronger U.S. dollar also weighed on raw material prices, depressing the currencies of major commodity exporters,” Mr. Federowski said in his article.

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M. Elmasry

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