Currency wars threaten Lehman-style crisis
By Liam Halligan, Telegraph
Global currency markets made front-page headlines last week as the euro plunged towards parity with a surging dollar and the pound similarly soared against the single currency.
But why is the dollar so buoyant and the euro spiralling downward? And should you lock in the strong pound by buying your summer holiday money now?
You may, quite reasonably, think that economic fundamentals, such as GDP growth and cross-border trade flows, still drive exchange rates.
Unfortunately, though, you’d be wrong. For we live in the age of “extraordinary monetary measures” and “central bank diktat”.
That may sound like a remote, jargon-laced statement, the musings of a nerdy economist. I’d say, in response, that the recent actions of Western central bankers are provoking not only heightened market volatility, but also increasing international conflict and the looming prospect of another Lehman-style systemic lurch. The dangers, sadly, are very real.
Currency dealers, and the ubiquitous computerised trading robots, are influenced far less these days by growth or inflation forecasts than by the market’s view on the origin of the next splurge of quantitative easing.
That judgment is driven, in turn, by the coded missives of central bankers like the US Federal Reserve’s Janet Yellen, Mark Carney at the Bank of England and, particularly in recent months, Mario Draghi at the European Central Bank (ECB).
Why did the euro fall to almost $1.05 last week, a 12-year low, having dropped some 12pc against the greenback since the start of the year? Why, when each pound bought you just €1.19 last March, can holidaymakers now expect €1.40 for every pound exchanged?
The main reason is the ECB’s long-awaited programme of virtual money-printing, which launched last Monday. Under euro-QE, the eurozone will be flooded with at least €1,100bn (£825bn) of newly created money over the next year and a half, as the Frankfurt-based central bank buys government and corporate bonds at the rate of around €60bn a month.
Like some kind of economic horse-whisperer, Draghi then commented that the eurozone economy is “now pointing in the right direction”, apparently raising the prospect of even-faster ECB money-creation, so depreciating the euro even more. As such, at the time of writing, the single currency has dropped over 6pc in six days, a pace of decline seen only once since the euro was launched in 1999 – and that was just after the 2008 Lehman Brothers collapse.
The other major cause of the single currency’s recent fall is that the Fed – having already indulged in its own vast money-printing programme, which saw America’s central bank expand its balance sheet threefold as a percentage of annual GDP over five years – could soon be weaning itself off the monetary steroids.
As such, for the first time in almost a decade, US interest rates may be about to go up. Expectations are rising, ahead of a key policymaking meeting this week, that the Fed will drop its pledge to be “patient”, pointing to a rate rise perhaps as early as June. Such a prospect, of course, pushes up the dollar.
So, as a result of ECB money-printing and US central bank musing, the dollar has lately soared against the euro. After months of speculation that Fed QE is finally over and rates will soon increase, America’s currency has rocketed 25pc against a trade-weighted range of currencies since May, with the dollar index now at its highest level since 2003.
The reality, of course, is that the Fed’s successive doses of QE since late 2008 have been designed to keep the lid on the dollar, deliberately reining in the greenback in a bid to boost US competitiveness and limit the value of the vast debts America now owes its foreign creditors – not least China.
The eurozone, meanwhile, having initially had to bow to German objections, has so far implemented QE more covertly, expanding its balance sheet slower than the US – and the UK for that matter. As such, the ECB has used complex transactions beyond the gaze of voters in member states where central bank profligacy is frowned upon and money-printing has previously gone badly wrong – sparking inflation, political extremism and worse.
The perpetually moribund eurozone economy of recent years, though, to say nothing of a currency union that stumbles from crisis to systemic crisis, means euro-QE is now, apparently, OK. In other words, the eurozone can finally get its own back on the US and Britain by attempting to print its way to a cheaper currency, winning back some competitiveness. That’s the theory, anyway.
What we’re seeing, then, is the West’s very own version of “currency wars”. For almost half a decade, the big emerging markets have complained bitterly – and often publicly–- about mass money-printing by the world’s “leading economies”. The likes of Brazil and China have highlighted, rightly, that Western QE has lowered the relative value of their carefully accumulated dollar and sterling reserves (and debts) against local, emergent currencies such as the yuan and the real.
Now, with eurozone leaders engaging in fully blown QE, and rejoicing at the euro’s fall against the dollar, currency wars are taking place not just between the developed world and the emerging markets but between the developed nations themselves. Japan, of course, is also part of this intra-G7 currency conflict, having lately launched an astonishingly extreme QE programme designed to pump up the Bank of Japan’s balance sheet from just over 20pc to no less than 75pc of annual output within three years.
As such, the world’s leading economies have reduced themselves to blatantly competing less on the quality of what they produce, than on the speed with which they can depreciate their currencies against one another. The lessons of history are that such situations are prone to escalate into rancour and, ultimately, conflict. That’s the unfortunate truth.
We are, then, a very long way from normal. Consider that the ECB is launching its QE programme at a time when real interest rates are already negative. As such, historically ultra-loose monetary policy is now being made even looser. Myopic politicians like QE – because, by rigging sovereign bond markets, it allows them to keep borrowing and spending. Mismanaged banks also like QE – because it means they sell their burnt-out, under-performing investments to the state and pretend they’re solvent, which avoids the discomfort of going bust.
Meanwhile, respectable people are increasingly alarmed, raising concerns about “extraordinary measures” that some of us have been voicing for years.
The head of the Dutch central bank, having not previously complained publicly, last week admitted that euro-QE, by propping up spendthrift governments, would shield the likes of France and Italy from “market discipline”, postponing vital reforms. A senior Goldman Sachs banker added that negative interest rates are “freaking him out”.
And no wonder. For the longer profligate eurozone governments are able to ramp up borrowing, the more likely monetary union is dramatically to implode. And the further share prices are pumped up by QE and other monetary mutations, the more vulnerable global stock markets are to crash.
For now, as the euro weakens, the pound looks strong. While that’s bad news for UK exporters, it does make your holiday pounds go further. Consider, though, that while sterling is soaring now, we’re facing in May the most uncertain general election for decades. A minority Labour government, propped up by an increasingly Left-wing Scottish National Party – a distinct possibility, even if the Tories win the most votes and even the most seats – could see sterling plunge.
In the end, you see, whatever the actions of politicised central bankers, the fundamentals win.