The last 10 days have seen turmoil in major currency markets:
- The Swiss National Bank gave up trying to devalue versus the euro, and the franc jumped 30% in minutes
- The European Central Bank (ECB) launched its €1tn Quantitative Easing (QE) programme, causing an immediate 3% fall in the euro’s value versus the dollar
These are major moves by any historical standard, and highlight how earlier ‘currency wars’ have broadened in scale.
Their origin was in 2009, when the US Federal Reserve launched its first QE programme. One of its key impacts (whether intentional or otherwise) was to devalue the US$ – thereby supporting export growth and the US economy. By 2011, after the Fed’s QE2 programme, the US$ Index was down 19% as the chart shows.
But then the Bank of Japan launched its own QE programme. And in October last year, when the US$ Index seemed likely to fall again, it launched its QE2 programme. Last Thursday, the ECB began its own QE programme, effectively joining the war on Japan’s side.
Japan and Europe have ageing populations and so cannot generate domestic growth. By weakening the currency, the ECB and Bank of Japan expect to compensate for this by generating growth in export markets. In turn, however, these competitive devaluations create major risks for the global economy, as the greatest central banker of modern times, Paul Volcker, has explained:
“Central banks are no longer [acting like] central banks,” he warned, amid a discussion about Japanese and American monetary policy. I think it gets dangerous when they lose sight of the basic function of the central bank. The key issue concerns what this “function” should be. The basic function of a central bank is to defend the value of the currency,” he insists, as his highly successful experience in the 1980s “taught him how limited a central banker’s powers really are”.
CHINA HAS ABANDONED STIMULUS FOR A ‘NEW NORMAL’ APPROACH
The problem is that currency wars are a zero-sum game. Today, Japan and the Eurozone are winning at the expense of the USA and Switzerland. Thus the US$ Index has broken out of a 30-year downtrend, and is at an 11-year high.
Effectively, though, this means that 2 of the world’s 4 largest economies are effectively waging a currency war against the largest economy, the USA, as well as against Switzerland. This cannot end well.
Within a few weeks, the Fed will find that the US recovery is suddenly weakening again:
- The collapse of the shale gas/oil bubble means US jobs growth will soon reverse, and housing starts slow
- US companies will lose market share in export markets as Japan and Europe become more competitive
- The rise in the value of the US$ will also help to ensure that the US slips into deflation.
- And so the Cycle of Deflation will likely move forward another stage, towards protectionism and tariffs
Of course, there is another way forward, which avoids this zero-sum game.
China’s new leadership realised 2 years ago that its previous policies had been a complete mistake. It has since adopted ‘New Normal’ policies, based on an acceptance that ageing populations inevitably lead to lower economic growth. As Zhou Xiaochuan, governor of the People’s Bank of China, told the World Economic Forum in Davos last week:
“If China’s economy slows down a bit, but meanwhile is more sustainable for the medium and long-term, I think that’s good news”
Unfortunately, very few of his peers seem to be listening to his common sense message.
WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 57%. “Current market fundamentals do not support any significant upturn on benzene pricing”
Brent crude oil, down 53%
Naphtha Europe, down 53%. “Buying appetite in downstream petrochemical markets is thin as polyethylene players wait for the February ethylene contract to settle”
PTA China, down 44%. ”Buyers were mostly purchasing on a need-to basis, adding that the market outlook remains uncertain”
¥:$, down 15%
HDPE US export, down 23%. “Most domestic export prices continued to slip on lower ethylene and energy market values”
S&P 500 stock market index, up 5%