A Currency War? Think Again

Lior Alkalay - INO.com Contributor - Forex

More and more of the world's central banks are moving into negative interest rates and/or Quantitative Easing; the Bank of Japan has a massive ¥80 trillion in QE (per year), the European Central Bank with its estimated €1.1 trillion QE and negative deposit rates, the Swiss National Bank recently moving deep into negative territory, setting interest rates at -0.75% and now the Riksbanken, Sweden's central bank, following suit with interest rates set at -0.1%. And as this process escalates, two words dominate the commentaries: currency war. That word combination, so frequently bandied about by economists, financial analysts and media pundits, embodies the attempt by nations to devalue their currencies in order to increase exports and inflate demand. Yet despite headlines outlining how the currency war between nations can escalate inflation, in almost all major economies, inflation continues to plunge. The question is why? The answer might not only surprise you but put a question mark on the so called "currency war."

US and China Already Stopped "Playing"

One of the biggest facts that economists seem to ignore when warning of a currency war is that the world's two main players, the US and China – the two largest economies and arguably the two which started this so-called "war" – have long been out of the game. The US Federal Reserve Bank halted its massive QE program in October and allowed the US dollar to appreciate since then by more than 14% against the Euro and more than 10% against the Yen. Moreover, the Fed is seen as the only central bank that is seriously considering a rate hike, the total opposite of devaluation. China, meanwhile, perhaps the most aggressive currency manipulator in the world (with the US a close second), has not only stopped devaluating its currency but in fact has allowed its currency to appreciate so much that the Yuan has been the best performing currency in the world after the US dollar. The Yuan appreciated more than 8.5% against the Yen and roughly 12% against the Euro since October.

Although both countries aggressively manipulated their currency, their tools were somewhat different. The Federal Reserve used Quantitative Easing, which is essentially ballooning its balance sheet with printed money, a form of currency manipulation by any and all means. The People's Bank of China used to artificially lower the Yuan by purchasing dollars, which of course allowed its foreign reserves to balloon. Those were two very different methodologies, but the outcome was the same: the devaluation of the respective currency. Yet, as seen in the two charts below, China's foreign reserves have plunged by $105.5Bln from its peak and the balance sheet of the Federal Reserve has remained more or less stable, revolving around $4.4 trillion.

Chart courtesy of Tradingeconomics

Chart courtesy of the Federal Reserve

Why the War Ended

While the sense of an escalating currency war is looming in fact this war has aggressively de-escalated. Since 2007, the aggregate amount that the US and China injected into their respective economies amounted to a whopping $6.614 Trillion (not including other PBoC programs), an amount that dwarfs the current liquidity injections of the ECB, the BOJ and all the other central banks. One must wonder what is behind this dramatic change of heart which put an end to currency manipulation by the two biggest players. China, the more aggressive manipulator of the two, made a strategic decision; it no longer wants to be known as the "factory" to the rest of the world but rather it wants to become the world's largest consumer. Thus China allowed its currency to strengthen while lowering interest rates to encourage local consumption. In the US, the case was rather simple; the US has always been a consumer-oriented economy, and while it was hoped that US exports would eventually take the lead, it was actually the return of the American consumer that ended the need for devaluing the US currency.

What Could Trigger Another War?

PBoC Governor Zhou Xiaochuan has reiterated that they see no need to devalue the Yuan. As one might expect, it is inflation, yet again. While inflation in the US is stable in China it's taking a plunge, falling to 0.8% as of late. Although with interest rates at 5.35% the PBoC still has plenty of room to maneuver, one thing is clear and that is if things turn ugly in China and inflation turns into deflation, even after a rate cut, then China might go back to the good old tried and tested method of manipulating the currency. With China experiencing a prolonged deleveraging cycle, this risk exists. But until then, while the headlines may scream currency war, understand that it's a scare tactic. If anything, the currency war has dramatically de-escalated and if things don't deteriorate from here, it could mean that the currency war that everyone is busy screaming about has essentially ended.

Look for my post next week.

Lior Alkalay
INO.com Contributor - Forex

Disclosure: This article is the opinion of the contributor themselves. The contributor does have an interest in the USD/ILS rising as of the date of publication. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

8 thoughts on “A Currency War? Think Again

  1. Your article explains to me why Wal Mart etc are really increasing minimum wages. It's not just to retain good employees. The American consumer is back and as Henry Ford showed, when he doubled wages 100 years ago, when consumers have money they drive the economy and everyone benefits.

  2. Having the US graph start at 0 and the Chinese graph only go from 380,000 to 400,000 makes it look like the US is stable and big things are going on in China. It is a dishonerable graphing pair.

    1. Hi Vince,

      Thank you for your feedback. The intention of the two charts is to show balance sheet trends in the past few months. Of course if we have presented the charts going back a few years both would be ascending. Yet this would make it hard to identify recent trends since 2014 , which is the point of the article.

      Hope this clarifies and again thank you for taking the time to write your opinion.
      Thank you.

  3. I agree with that possibilities of ending Currency war but that will be limited for "Words" or "Context" used therefor it, or any traditional functional meaning, we have accepted otherwise, Considering certain past experience from EU, SWISS or JAPAN or China's Central Bankers, or alternatively Considering Global Economic situation, it is quite hard to predict the end of currency war, if it will too, that will be a simple change in the pattern or type or style of war, and which may not fully depended on currency either in direct role or straight line involvement thereof, but with some different characteristics, or with some changed modes operandy, process of such quasi war will be continued, infect, at this juncture, it is now become essential to survive, and nobody just cant dare even to think to stop it.

    As per my view, now every players will change their Focus or instrument, whatever action, going to be taken place, will be more and more surprising, and being a policy changes, some fresh, unexplored, non traditional and absolutely unexpected measures will be announce purposely.

    When every one have same wine to sale, you are bound to change either it's name or Bottle, however, ultimately just wine only will be sold.

  4. I get the feeling all major central banks are getting ready for a reset of global fiat currencies.

  5. The Currency Wars are hardly over. Every country is yearning to find some means of generating inflation -- to constant failure. Even in the US inflation (you say is stable) but excessively low. Everywhere else economies are floundering under flat to negative inflation. Growth? Where? So they're whacking their currencies in the hope of stimulating historic growth rates. To no avail.

    The reason the dollar is king right now is that the US was first to devalue. The dollar should have dove under the ice and froze there. But instead it just churned higher due to every other country failing to grow and therefore whacking their own currencies. We're gonna see 100+ on the DiXi soon. Great time to travel. Suck time to export your cars/trucks/software/maplesyrup.

    No, the Currency War is in full swing right now. And the US can't figure out it if it likes being uber strong or whether it would rather have cheap dollars to pay off its debts. See the rake hike pushed into 2016 easy! The FED want's to see some country -- any country -- take up the slack in this FX tug-o-war before they pour gasoline on the Dollar fire.

  6. I think that the "currency war" is more reasonably called the "PertoDollar war", and that is being fought over the "reserve status" of the Dollar. If the US were to become "energy independent" due to "fracking" and tar sand, or more off shore drilling; and we started selling oil on the market, it would be to our advantage to have a strong dollar...but that seems unlikely, at the present price of oil...Our "friends" the Saudis, have figured out that they can increase market share and decrease competition by pumping enough to keep the price down and thereby drive the Frackers out of business. Once US production declines and the threat of selling into the market is removed, the price will be back under OPEC control, and the World Bank will revalue the SDR, possibly including the Rembi. That will be the end of the Dollar's Reserve status, and to a 20% drop in the Dollar....So, watch oil imports into the USA, for indications about timing the oil market.

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