In its 1963 review of Stanley Keramer’s "It's a Mad, Mad, Mad, Mad World!", a film about a group of amusing characters fighting each other and ravaging the landscape over buried treasure, New York Times wrote:
It's a wonderfully crazy and colorful collection of "chase" comedy, so crowded with plot and people that it almost splits the seams of its huge Cinerama packing and its 3-hour-and-12-minute length. It's mad, as it says, with its profusion of so many stars, so many "names," playing leading to 5-second bit roles, that it seems to be a celebrities' parade. And it is also, for all its crackpot clowning and its racing and colliding of automobiles, a pretty severe satirizing of the money madness and motorized momentum of our age.The piece is a fitting description of central banks’ engagement in the currency war over fragile global demand for exports where there have been no victors as economies remain ravaged and prospects get gloomier. The war that has been raging since 2010 has intensified this year, mainly because of the ineffectiveness of monetary policies’ in generating growth. Even though that global financial imbalances are responsible for various countries’ output and labour market gaps and large twine deficits policy makers are wishfully keeping their monetary stance extremely loose to perhaps gain the so-called “escape velocity” to break free of these predicaments.
Not surprisingly, “Currency war” is a desperate measure, which includes the bizarre negative interest rate that inflicts cruel horrors on pensioners, savers and fixed income earners. It is damaging Banks and insurance companies’ business models, and at a macro level it destroys and distorts market signals as well as market infrastructures.
In Japan, a covert currency war was declared by the newly elected government of Prime Minister Shinzo Abe at the end of 2012, when his government demanded that Bank of Japan should adopt a higher inflation rate target, to which the Bank obliged by its large-scale asset purchases. Subsequently, when the Greenback fell below 108 yen for the first time in 17 months on April 7th this year, Japan’s finance minister Taro Aso cautioned against a rapid rise in the yen, saying he would take necessary steps to offset “one-sided” moves in the currency market.
“A rapid move toward either yen rise or yen fall is not desirable. It is desirable that currencies are stable at levels that match the economy’s fundamentals. (…)Aso warned. However, in the first quarter of this year, Aso's negative policy interest rates and the prospects of more intensified currency wars backfired and caused a sharp appreciation of the yen against the dollar and adversely affected the equity market.
As the G20 confirms, excess volatility and disorderly moves in the exchange market hurts (economy), so we are watching currency moves with a sense of urgency. We will take necessary steps under certain circumstances,”
On the other side of the Pacific, in her currency-war's battle cry on March 16th, the Federal Reserve chair, Janet Yellen, warned her counterparts at various central banks that in a world with highly integrated capital markets, monetary policy actions in any country will have spillover effects to other countries through exchange rates;
That’s true of our monetary policy, and it’s true of other countries’ monetary policies. In part, that shows up through movements in exchange rates, and those movements are a factor that any country needs to take into account in deciding what is the appropriate stance of monetary policy. So the fact that there are these linkages is an important factor in designing a monetary policy.
Hence, she implicitly served notice that she cannot ignore the adverse effects of the other central banks' policy moves on the U.S. economy and reiterated the Fed policy objective to maintain a weak dollar as a policy tool to insure against a growth slowdown, despite the fact that the US inflation is now virtually on the target. She noted that:
“Manufacturing and net exports have continued to be hard hit by slow global growth and the significant appreciation of the dollar since 2014. These same global developments have also weighed on business investment by limiting firms' expected sales, thereby reducing their demand for capital goods; partly as a result, recent indicators of capital spending and business sentiment have been lackluster.”Consequently, Ms. Yellen left interest rates unchanged and signaled her resolve to fight currency wars by hinting at only two further contingent rate hikes this year relative to the effect that, heading into 2016, the market was pricing in four rate hikes. “Importantly”, she emphasized:
“this forecast is not a plan set in stone that will be carried out regardless of economic developments. Instead, monetary policy will, as always, respond to the economy’s twists and turns so as to promote, as best as we can in an uncertain economic environment, the employment and inflation goals assigned to us by the Congress.”
In the ECB, Governor Mario Draghi has also manifested his determination to intensify his initial opening salvo of introducing QEs in March 2015, which at the time he said the effort would run at least until September 2016, with an initial value of 1.1 trillion euros. Then in December, he cut ECB’s deposit rate deeper into negative territory, arguing:
"We have the power to act. We have the determination to act. We have the commitment to act,"He intensified the ECB barrage in this ruthless race to the bottom for currencies this March with a fresh round of monetary stimulus including pushing the Bank’s key deposit rate deeper into a historic negative territory of -0.4 per cent and stepping up the pace of quantitative easing (QE) from 60 billion euros to 80 billion euros a month. Moreover, he cut the Bank’s benchmark interest rate from 0.05 percent to an all-time low of 0 percent, while announcing plans to extend its bond-buying program to include corporate bonds as well as government bonds, in a futile effort to raise the Eurozone inflation rate in a recessionary environment.
Surprisingly, some market participants have interpreted Draghi’s move as “de-emphasizing the role that the exchange rate plays in easing financial conditions," not taking into consideration that most probably the higher euro level may have been caused by the collateral damage in the currency wars and not by Mr. Draghi’s statement that: “We don’t anticipate it will be necessary to reduce rates further,” which was interpreted by some as to mean a shift away from the "currency war" – i.e, the -0.4 percent will be the ECB's last rate cut in the negative territory.
Looking forward, it is reasonable to maintain the hypothesis that the euro will depreciate against the dollar when Mr. Draghi would realize that his offer of ceasefire has not been accepted and will be forced to do ‘whatever is needed’ again to prevent a depression.
What about Britain, where the central bank has left its key interest rate at a record low for seven years? The readers of this blog may recall that in August last year we raised concerns about the British economy’s pace of growth and productivity, cautioning:
The fact that growth in the UK productivity has been subdued in the past eight years is a clear indication that British investors are still quite hesitant to invest strategically to enhance competitiveness.Furthermore, we argued that Britain’s moderate investment growth would not be sufficient for the needed restructuring and the crucially necessary enhancement of her competitiveness. Sure enough the recent data showed that Britain's industrial output -- which makes up 15 percent of Britain's economy -- shrank at 1.5 per cent, the fastest rate in more than three years over the three months to February and the trade deficit ballooned to its widest in eight years.
In fact Britain's National Institute of Economic and Social Research (NIESR) now estimates that the overall economic growth in the first three months of 2016 had almost halved to just 0.3 percent, which would be the weakest rate of growth since the end of 2012.
Since August, the British pound depreciated by 7 per cent, however this decline has not been engineered by the Bank of England. Recall that last August we wrote:
A participation in the current currency war, even when British pound has appreciated 20% on a trade-weighted basis since March 2013, would not be an option. As it would either worsen the public sector net borrowing, or further reduce the effectiveness of monetary policy, and exacerbating household high level of debt.In fact, the Sterling depretiation was driven mainly by the uncertainty associated with the BREXIT.
The Outlook
Unfortunately, despite the ineffectiveness of unconventional policies in reviving the potential growth and productivity and the severe damages that these policies afflict on the market infrastructure and trade, Ms. Yellen has stated in her recent speech that;
Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy--specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities.
While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed.
Her influential predecessor Mr. Bernanke has gone even further and in his recent blog has advocated Helicopter money:
I consider the merits of helicopter money as a (presumably last-resort) strategy for policymakers. I make two points. First, in theory at least, helicopter money could prove a valuable tool. In particular, it has the attractive feature that it should work even when more conventional monetary policies are ineffective and the initial level of government debt is high. However, second, as a practical matter, the use of helicopter money would involve some difficult issues of implementation. These include (1) the need to integrate the approach with standard monetary policy frameworks and (2) the challenge of achieving the necessary coordination between fiscal and monetary policymakers, without compromising central bank independence or long-run fiscal discipline. I propose some tentative solutions for these problems.
Apparently, Ms. Yellen, Mr. Bernanke and other central bankers do not believe in any intertemporal optimization, i.e., too much borrowing now only transfers consumption across time from the future toward present. This partly explains why currency wars, lower interest rates, and various QE programs have done little to restore growth.
Policy makers should realize how important the role of capital formation in the supply side is. They should realize that for a successful working of international trade currency values, like any other price signals, must be informative about their relative purchasing power, and these can only be discovered in transparent markets, where the fundamental relationships between financial assets and the real sectors are respected -- where the banks are healthy and tax payers are not on the hook for the rescue of Too-Big-to-Fail zombie banks.
