Forex Focus


The spectre of 'currency wars'



Some central bankers bemoan their strong currencies while others adopt either covert or overt weak currency policies

‘Currency wars’ are all the talk of the City as some central bankers bemoan their super-strong currencies (for example - New Zealand, Switzerland, Brazil) while others adopt either covert (UK) or overt (Japan) weak currency policies.

The ‘currency wars' started in 2003, when the US Federal Reserve cut interest rates to 1 percent. Or maybe they started earlier still, back in 1992. That's when the Fed cut rates to 3 percent and forced countries in Asia that had pegged their currencies to the dollar, to cut interest rate and intervene maintain their FX pegs. Capital flooded in and bank lending surged, fuelling a property/credit bubble that became a crash, from Bangkok to Seoul.

The US cut rates in 1998 after a hedge fund went bust and that helped get the dot.com and housing bubble started. In 2001 the dot.com bubble burst and the economy went into the mildest recession ever. The Fed cut rates to under 2 percent (from over 6 percent) in 2001, but then went on cutting, to 1 percent in 2003.

That set global monetary policy on ‘Go’, and absurdly cheap money fuelled the credit bubble that turned into a banking crisis and the worst recession in a lifetime. Setting US rates ludicrously low also caused the dollar to go down - against the euro, the yen and even, until 2008, the pound sterling.

Now, with central banks running short on ideas to boost their economies and governments desperate for central banks to do more because they have (almost) run out of room to increase their borrowing, anyone who doesn’t want to set their interest rates at zero is lumbered with a strong currency and some of them don’t like it.

Indeed, the countries with huge current account surpluses and export industries that can live with a strong currency (for example Norway, Switzerland, Singapore), get strong currencies even if they do set their rates at zero. Many others are left with a policy mix they don’t want - rates too low that send asset (most visibly housing) prices up, and a currency that is too strong. You can count cranes in Toronto or watch a housing boom in Stockholm, the picture is pretty universal.

The world’s political leaders abhor currency manipulation - that is to say, they don’t like countries engaging in beggar-thy-neighbour policies to weaken their currencies - but they do like zero rates, and quantitative easing and anything that boosts global demand. That’s a bit like supporting war on condition that no-one gets hurt.

The US holds most of the cards - the Fed sets global rates and can finance its (huge) debt levels as other countries resist FX appreciation by intervening, and then buy US assets. But the US will also ‘win’ this war, as its economy pulls ahead of Japan and Europe's. Japan was the big ‘loser’ but is fighting back and increasingly it’s the Euro which is strong as the German contingent at the ECB finds voice and the sense of crisis fades.

In the background, a revaluation of the currencies of the ‘emerging’ economies, which have made huge leaps in their share of global economic output, is desirable but disorderly. And what of the pound sterling? Worst-performing of the major currencies since the crisis started, it can fall further. It seems that the Bank of England’s Monetary Policy Committee and the Government would welcome a weaker pound. It’s a shame that does so little to help exports, the benefit being eaten up so far in exporters’ profit margins.

The UK just doesn’t have many price-sensitive exporters anymore: They were all weeded out over years of a strong currency and re-balancing the economy with the help of a weak currency would/will take decades, and require fundamental industrial, educational and financial reform. So for now, a weak pound helps export profits more than export volumes, and drives up import and consumer prices for the rest of the economy. Thanks for that, Charles and Mervyn!

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About Author

Kit Juckes is the head of foreign exchange at Société Générale (SG). He joined SG in June 2010 from the ECU Group, a London-based currency management boutique where he was the chief economist. Kit has over 25 years of experience as an economist, bond, currency and credit strategist. He has worked in the UK, US and Germany. He was born in Kenya, brought up in Paris and now lives in London with his wife and children.

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