Russia’s decision to slash the value of the ruble on Monday renews fear that a destabilizing round of currency devaluations will soon pummel Asia and Latin America, prolonging the global financial turmoil that threatens to undermine the U.S. economy.
There will be little immediate impact on most U.S. businesses or investors from the 34 percent devaluation in the ruble. Russia’s $450 billion economy is not large by global standards and only a handful of American firms have major operations or trading relationships there.
But the companies and banks that have invested in Russia are under intense pressure to accept large losses on their holdings. And the flight of foreign capital from emerging markets that began last summer with devaluation of the Thai baht will intensify as skittish investors continue to seek safer havens.
“There’s a contagion in terms of sentiment, even if there are no fundamental ties between these countries,” said Farid Abolfathi, director of emerging-market research for Standard & Poor’s DRI forecasting unit. “Portfolio managers have been liquidating their emerging-market holdings even in countries that don’t have the fundamental problems of Russia.”
Wall Street shrugged off the devaluation Monday as stocks posted a gain. But the more meaningful effect on the real economy lies down the road. If foreign countries continue to devalue their currencies and impoverish citizens and businesses, that will diminish markets for U.S. exports.
It also will exacerbate the flood of cheaper imports coming here. Last year’s Asian devaluations have sent the U.S. trade deficit soaring, which depresses growth. The profit slowdown of the past quarter, which hammered the stock market, is largely attributable to reduced sales to Asia that resulted from the currency devaluations that began there last summer.
For Russia, the immediate impact of ruble devaluation will be to throw its economy, which grew last year for the first time since the fall of Communism, into recession. It also will force its troubled banking sector to restructure its debts. The foreign investors hit hardest by that will be the Europeans, especially the French and Germans, who have invested more heavily in Russia than American investors.
“The impact on Europe will be the same as the impact that Asia had on the U.S.,” said Carl Weinberg, chief economist of High Frequency Economics of Valhalla, N.Y. “The U.S. was strong enough to take the hit. The European recovery is much more fragile and has been export led. This could set off a growth recession there.”
The International Monetary Fund’s reaction to the devaluation indicates those European investors and the handful of U.S. investors with Russian portfolios are under pressure to accept larger losses on their investments. IMF Managing Director Michel Camdessus, in a statement issued from Moscow, called on the Russian authorities to “spare no effort to find a cooperative solution to their debt problems, in a close dialogue with Russia’s creditors.”
The Russian devaluation came after a week of turmoil in financial markets that began when it appeared the poorly regulated Russian banking system was on the brink of collapse. International Monetary Fund officials rushed to Moscow over the weekend, hoping to show support for an economy aided with an additional $11.2 billion from the lending agency just last month.
IMF economist John Odling-Smee, the agency’s chief Russian expert, took part in the consultations over the weekend that led to the devaluation, a spokesman for the agency said.
But the most important ripples from the Russian currency collapse as far as the United States is concerned will be felt elsewhere, especially in Asia.
“You’ll probably have some additional contagion,” said Morris Goldstein, a senior fellow at the Institute for International Economics and a former senior official at the IMF. “This is another case of a country not being able to hang on.”
The biggest fear is that it will spread to China, which last devalued its currency in 1994. Chinese President Jiang Zemin has repeatedly pledged to hold the line on the yuan, pegged at about eight per dollar.
But with massive flood damage from this summer’s rains and millions of workers facing layoffs due to restructuring in its state sector, the government is under intense pressure to keep growth rates high through exports to keep unemployment from skyrocketing.
Devaluing the currency does raise exports and promote growth in the short run. But, as happened last year, it usually leads to competitive devaluations among a country’s competitors.
In China’s case that’s Indonesia, Thailand, South Korea and the other exporters of East Asia. Competitive devaluations lead to a downward spiral of lower prices, lower earnings and further financial turmoil.
“We expect devaluations in both Hong Kong and China within six months if not sooner,” Abolfathi said. “They would prefer to do it when markets are calm, but devaluations elsewhere have made their exports less competitive.”
Ironically, it may be the reaction of the Russian people to the ruble’s devaluation that holds the Chinese in check. Recent tax increases and the devaluation have cut most Russians’ spending power by about 50 percent.
“If the Russians have no social unrest, and their banking system restructures successfully, then the Chinese will be encouraged to do the same,” Weinberg said. “What they fear most is social unrest.”
Clinton administration officials are struggling to balance these competing political and economic interests. While Russian unrest may keep the Chinese from devaluing, it runs the risk of destabilizing the government of President Boris Yeltsin, which could put either the nationalists or Communists in charge. That would undo the administration’s five-year effort to lead Russia toward a market-oriented economy.
U.S. Treasury Secretary Robert E. Rubin on Monday called on Russian authorities to “move quickly to take actions to restore confidence, including the adoption of a careful and cooperative approach to dealing with its creditors and the full implementation of the measures outlined in the Russian stabilization program agreed with the IMF.”
