The Currency Wars

The Currency Wars

Two good jobs reports, one in the US and one in Australia have exposed the economic war that is being waged around the world. It is a war between currencies that is out of the hands of government authorities and is fought in the battlefields of the foreign exchange markets. Currency wars by Harry Notaras

 

Whereas debate rages on the actions to be taken with respect to interest rates and fiscal policy, all we can do when it comes to exchange rates is stand back and look on in impotent hope. It is impotent hope because if every country was successful in devaluing their currency to the same extent, maths dictates there would be no movement at all because one currency’s depreciation is another currency’s appreciation. We cannot all depreciate equally. What then, are we left with other than interest rate policy since fiscal policy is out of bounds for ideological reasons?

 

The integrity of the Federal Reserve will be tested when it meets in December to determine whether the long awaited move away from the Zero Interest Rate Policy (ZIRP) will finally take place. The chairman of the Fed has done a less than sage like performance when it comes to positioning herself for this moment. The board has been snookered into a position where expectations are that the journey towards ‘normalising’ interest rates will begin and this has been reinforced by the positive job creation news in the US. If the Fed is to avoid this scenario the Fed will have to take a very courageous move by going against the weight of expectations to start increasing interest rates.

 

The Fed may fudge this by increasing interest rate in order to pacify market expectations and then making a statement along the lines that any further increases be very gradual and only as circumstances warrant. Given the rabid stance taken by market participants on such things it is not likely to be a very successful approach to take. It will eventually become apparent that signs of inflation are still not apparent and that any rate increase will only act to retard economic growth which is desperately lacking around the world. It will be a defining moment for the Fed and its President.

 

Meanwhile in Australia we have had a surprising drop in our unemployment rate which will provide a bit of relief to the RBA which very recently would have been considering using up some of its scarce powder and lowering the interest rates another quarter of a percent. The immediate reaction to this news was a one cent appreciation in our currency against the US. This was on the presumption that the need for a further cut in interest rates has receded and that there is a slightly higher chance that the next rate movement will be up.

 

This would be folly. In both the US and Australia, inflation rates are low. It would be foolishness to increase interest rates when prices and wages are relatively stagnant. Added to that is an argument that the target inflation rates as they now stand for both countries are probably too low. The RBA may be looking on in the hope that the Fed is drawn into raising the interest rates. This will allow us to resume a course of devaluation against the US and provide further stimulus to our economy. This is a slightly macabre hope as we will be feeding off the ill fortune of the US which would also benefit from depreciation. Such is life.

 

If the US Federal Reserve does not raise interest rates in December, its president will have taken a big bet that will either immortalise her or sink her. I wish her well.

 

Harry Notaras

Harry Notaras ABS Business Sales

Business Broker - ABS Business Sales

Phone: 07 3368 4010

Mobile: 0434 344 282