Paris (AFP) – The euro’s slide against the dollar has reignited talk of a “currency war”, with analysts in opposing camps over whether or not countries are consciously playing with their exchange rates.
War language is no stranger to modern monetary policy.
The massive bond buying programmes, or quantitative easing (QE), that central banks have used in response to the financial and economic crises that have rocked the global economy since 2008 are often referred to as a bazooka.
After lowering interest rates, sometimes to zero or even into negative territory, major central banks turned to buying government and corporate bonds to stimulate the economy.
First tried by Japan in 2001 to combat deflation, the US Federal Reserve began using it in 2008 to respond to the financial market crisis and pull the US economy out of recession.
Japan used QE with more success in 2013 after Shinzo Abe came to power, and the European Central Bank joined the party in March.
– Monetary policy bazooka –
But central banks fired this bazooka as governments had little they could do.
“We are really in a situation where monetary policy has substituted for budgetary policy” as “the governments don’t have any more budgetary margin for maneouvre,” said Saxo Banque economist Christopher Dembik.
And the bazooka wasn’t directly aimed at exchange rates.
The bond purchases inject money into the economy, thus addressing any concerns about market liquidity. To the extent the funds result in new investments in the real economy it stimulates growth, another aim of QE policies.
But some funds end up leaving the country as investors seek better returns elsewhere. This pushes the value of the currency down, which is also not an unwelcome effect for policymakers as this favours more exports of goods and services and thus growth.
“The currency weapon is rarely the official objective,” said Patrick Jacq, a bonds specialist at BNP Paribas bank.
Led by Brazil, developing countries charged that the US QE programme was a first shot in a currency war because their economies suffered as exports slumped thanks to the weak dollar.
Those complaints were brushed aside with commitments by the leading economies to “market-determined exchange rates”.
But public comments from elected officials about currency values often muddy the waters about policy objectives, even if central banks in most major economies are independent.
Lowering a currency’s value may not be the stated policy objective “but they are thinking it so loudly all the world hears it,” said Rene Desfossez, a bonds specialist at Natixis investment bank.
The reason is clear as “the exchange rate is one of the principle levers on which they can use to make monetary policy as favourable as possible for economic recovery”.
A weak currency can provide a boost to exports, and thus contribute to a wider economic recovery if companies raise wages and create new jobs.
– Policy free for all –
And UniCredit’s global chief economist, Erik Nielsen, observed recently that days of “gentlemanly” cooperation between central banks is long gone.
“I am not in the ‘currency war’ camp, but it is important to note that the world’s leading central bankers are now making it explicitly clear that they run monetary policy for their own country only,” he said in a note to clients.
“And while the currency is not an explicit objective in their policy set-up, the FX is seen — and explicitly referred to — as an integral part of creating the desired financial conditions for the domestic economies.”
More countries have been joining on the easing bandwagon, either on their own initiative or in response to others.
The Organisation for Economic Cooperation and Development noted recently that monetary policy in countries accounting for roughly half of global output had been eased in the past few months.
– ‘Not necessarily warfare’ –
But is it a currency war?
Editors at Bloomberg recently wrote that “this isn’t necessarily warfare”.
The eurozone, Japan and China all have ample justification for monetary stimulus, they noted.
One way of uncovering unfair currency manipulation, Bloomberg editors said, is to look at foreign reserves, which should increase if a country is deliberately buying foreign currency to keep the value of its currency low.
But no major country has been massively hoarding foreign reserves, according to Bloomberg data.
The massive swings in currencies in recent months — the dollar has appreciated by a quarter against a basket of major currencies since August — may be due more to monetary and economic dissonance.
While the eurozone and much of the rest of the world are easing monetary policy, the United States is on the cusp of raising interest rates from the zero level where they have been for more than six years.
The prospect of higher returns on US bonds caused a brief stampede out of emerging markets last year, and with much of eurozone debt now providing little if no return, the euro has been slumping against the greenback.
“As we have said for over a year now, the divergence in central bank policies is crucial to where these currencies move now,” said Greg Smith, an analyst at currency trading firm World First.
- exchange rates
- monetary policy
- currency war
- quantitative easing