Thursday

13th May 2021

Opinion

The monetary masquerade

  • Are we in the midst of an international currency war? (Photo: Wikipedia)

Since the great global recession, all major advanced economies have resorted to series of liquidity injections to alleviate fiscal challenges.

The unintended consequence is that the resulting massive monetary expansion defers vital structural reforms in the advanced world, while posing huge downside risks to the emerging and developing countries.

Read and decide

Join EUobserver today

Become an expert on Europe

Get instant access to all articles — and 20 years of archives. 14-day free trial.

... or subscribe as a group

Last Tuesday French President François Hollande complained that the euro should not be left fluctuating at the mercy of the “mood of markets.” As far as the Élysée Palace is concerned, the eurozone is asking some countries for competitiveness efforts, even as it is making their exports more expensive.

The European Central Bank (ECB) should have a foreign exchange policy, Hollande argued. "Otherwise we are asking countries to make efforts on competitiveness that are annihilated by the value of the euro."

When Spain and Italy were swept by market turmoil more than a year ago, the euro plunged to $1.20. Since then, the eurozone currency has appreciated steadily and sharply, peaking at $1.36 recently. In fact, the rise of the euro could continue for some time to come. Analysts believe the currency could soar to $1.45 against the dollar and stay there for a while.

Of course, President Hollande’s real target was not the ECB, but Berlin. "There are countries that have surpluses and high levels of competitiveness and others with deficits that have efforts to make,” he said. “Countries in the first situation should boost domestic demand to allow others to one day see a return to activity."

While the concern for the fluctuations of the euro may be valid, the proposed medication – mandating the ECB to run a foreign-exchange policy – is only politically unviable and could prove economically counter-productive. It would reinforce competitive devaluations rather than show a way out.

The current European currency debate is not exactly a new one, however.

From liquidity traps to economic stagnation

“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.”

This warning was made almost two and a half years ago by Brazil’s finance minister Guido Mantega. At the time, interest rates remained close to 11 percent in Brazil, in the aftermath of the quantitative easing by the Federal Reserve. “It’s no use throwing dollars out of a helicopter,” Mantega lamented.

Soon afterward, China’s vice foreign minister Cui Tiankai noted that “international confidence in the recovery” might be hurt.

In turn, Germany’s finance minister Wolfgang Schäuble called US policy “clueless,” while his South African counterpart Pravin Gordhan thought that the Fed´s move undermined the G-20 leaders’ “spirit of multilateral cooperation.”

While the debates center on “currency wars,” the underlying forces reflect a massive monetary expansion that serves to defer desperately needed structural reforms in the advanced world, while posing huge downside risks to the emerging and developing countries.

As the global crisis has exhausted the traditional instruments of monetary policy, central banks have been opting for new rounds of quantitative easing (QE). And, with investors seeking higher returns, more QE has been driving ‘hot money’ (short-term portfolio flows) into high-yield emerging-market economies.

Further, as the current monetary policies remain in place, they are growing less effective, but continue to inflate potentially dangerous asset bubbles in Asia, Latin America, and elsewhere.

The G-7 liquidity gamble

In September 2012, the Fed expanded its holdings of long-term securities with open-ended purchases of $40 billion of mortgage debt a month. It seeks to hold the federal funds rate near zero until 2015. The goal was to boost growth and reduce unemployment. The net effect is the huge acceleration of quantitative easing.

In late summer 2012, the ECB chief Mario Draghi pledged to do “whatever it takes” to preserve the euro. The pledge was followed by the Open Monetary Transactions (OMT) program, to provide liquidity to sovereign debt markets. The goal was to reduce tensions and boost market recovery in the eurozone.

Recently, the Bank of England's incoming Governor, Mark Carney, said that he would tolerate inflation above the BoE's 2 percent target rate to achieve stronger growth.

The Bank of Japan has raised its inflation target and pledged limitless stimulus. Meanwhile, the stimulus package of Shinzo Abe’s new government, coupled with the anticipation of aggressive monetary easing and reforms, has driven Japanese stocks sharply higher and the yen significantly lower – which could unleash a series of new currency rivalries.

During the past four years, the bloated balance sheets of these major central banks have doubled and then almost tripled to almost $10 trillion. What about the payoffs?

In the United States, stagnation has replaced sustained growth and unemployment remains nearly 8 percent. Labor force participation has plunged and monthly job creation is significantly below what is needed for a solid recovery.

In the eurozone, unemployment has soared from 7 percent to 12 percent and the area is in recession, again. In the ailing Southern periphery, the rate is twice as high and youth unemployment more than 50 percent. In Japan, the third lost decade has begun.

While monetary policies create a perception of stability, they also provide a pretext to defer structural reforms, which, in turn, creates a moral hazard.

In Washington, this status quo has resulted in a prolonged fiscal cliff. In Brussels, muddling through has postponed change. In Tokyo, the standoff has discredited a generation of political leaders.

In their zeal for competitive devaluations, advanced economies are competing against each other to achieve a relatively low exchange rate for their own currency. Unfortunately, such policies unleash retaliatory actions by other countries.

Moreover, the perception of stability could prove elusive if the US fiscal cliff fails to lead to a credible, bipartisan medium-term adjustment plan, if the eurozone is swept by new turmoil, or if markets would lose faith in Japan’s huge debt.

The bloated central bank balance sheets in the advanced world are no longer a means to an end, but a part of the problem.

The writer is research director of international business at India China and America Institute (USA) and visiting fellow at Shanghai Institutes for International Studies (China) and EU Center (Singapore).

Disclaimer

The views expressed in this opinion piece are the author's, not those of EUobserver.

Divided Europe, divided Eurozone

In the past few days, Brussels has been swept by a EU budget debate for the years 2014 to 2020, and the continuing saga of the Greek debt. Current solutions reflect old challenges and new divisions, writes Dan Steinbock.

News in Brief

  1. No EUobserver newsletter on Friday 14 May
  2. Germany stops Facebook gathering WhatsApp data
  3. Italy rebuts reports of EU deal with Libya
  4. MEPs demand EU states protect women's reproductive rights
  5. At least nine dead in Russia school shooting
  6. Bulgaria interim government appointed until July election
  7. German priests defy pope to bless same-sex couples
  8. New EU public prosecutor faults Slovenia

Column

'Sofagate' was more about power than sexism

Sexism may have played a role, but the deeper meaning of Ursula von der Leyen's humiliation in the palace of Turkish president Erdoğan is political and geopolitical.

Stakeholders' Highlights

  1. Nordic Council of MinistersNordic Council enters into formal relations with European Parliament
  2. Nordic Council of MinistersWomen more active in violent extremist circles than first assumed
  3. Nordic Council of MinistersDigitalisation can help us pick up the green pace
  4. Nordic Council of MinistersCOVID19 is a wake-up call in the fight against antibiotic resistance
  5. Nordic Council of MinistersThe Nordic Region can and should play a leading role in Europe’s digital development
  6. Nordic Council of MinistersNordic Council to host EU webinars on energy, digitalisation and antibiotic resistance

Latest News

  1. EU aims at 'zero pollution' in air, water and soil by 2050
  2. French police arrest Luxembourg former top spy
  3. Vaccine drives spur better-than-expected EU economic recovery
  4. Slovenia causing headaches for new EU anti-graft office
  5. 'No place to hide' in Gaza, as fighting escalates
  6. EU chases 90m AstraZeneca vaccines in fresh legal battle
  7. Fidesz MEP oversees FOI appeals on disgraced Fidesz MEP
  8. Belgium outlines summer Covid relaxation plans

Join EUobserver

Support quality EU news

Join us