Only romantics believe that love makes the world go ’round.
The rest of us know that it is really money that keeps the global economy spinning, and when money flows change direction, big exchange-rate moves can result.
The U.S. dollar has seen a big move down in the past 10 months, a drop of more than 10 per cent. Its recent fluctuations have been geopolitically driven, but analysis of global capital flows indicates that the big downtrend will resume once geopolitical uncertainties dissipate.
Of all the billions that churn in global financial markets daily, the money that carries the greatest commitment and lowest liquidity is foreign direct investment. Investors that buy companies or build facilities abroad expose themselves to unusual risks while laying the foundations for economic growth.
There was about $550 billion US in global foreign direct investment in 2002 – that’s a lot of money, but a big decline from the $1,500 billion in 2000 and $735 billion in 2001.
Why the decline in investor appetite? Part of the story is that international investment flows were artificially inflated in 1999-2000 by the U.S. technology investment bubble. A spate of international mergers and acquisitions always happens near the end of an investment mania, and this one was no exception.
Another part of the story is cyclical – 2001 and 2002 were slow years for the global economy, with GDP growth of 2.2 per cent and about 2.6 per cent, respectively.
But the big story is risk – financial crises, terrorism, war and the market mover of the year in 2002, corporate malfeasance. Revelations of corporate fraud have undermined faith in the U.S. stock market in particular. One consequence has been a major shift in global foreign direct investment flows away from the U.S., as it is seen as less of a safe haven than in the past.
Who is attracting these new investments? One big star is China, which attracted nearly 10 per cent of all global foreign direct investment in 2002, some $50 billion. Other strong performers are India, South Korea and the Czech Republic. Canada continues to fare well, attracting around five per cent of total global direct investment flows, which is far more than our two-per-cent share of the world economy.
But the big shift in investment has been away from the U.S. in favour of Europe, where there is plenty of scope for basic corporate restructuring and increased profitability. Meanwhile, the U.S. continues to borrow nearly $2 billion US per day to finance its current account deficit, but the source of those funds has shifted from direct investment mainly to foreign purchases of U.S. Treasury bonds. This softening in investor commitment has produced a steady decline in the U.S. dollar against most of the other major currencies, particularly the euro, since early 2002.
The bottom line? Foreign direct investment flows are adjusting to the new reality of increased global risk and the emergence of better investment opportunities outside the U.S. After a period of war-related volatility, look for the U.S. dollar to resume its downtrend.
(Stephen Poloz is vice-president and chief economist at Export Development Canada. You can reach him at spoloz@edc.ca)
