Combat Mode

Submitted by Academy Wealth Advisers on March 5th, 2015

Written by Rick Welch on March 5, 2015

Are central banks across the globe really in combat mode as suggested recently by CNBC correspondent Sara Eisen in her article entitled “Currency War: Who will be the casualties?” Ms. Eisen wrote that the term “currency war was a phrase coined by former Brazilian Finance Minister Guido Mantega in 2010 to complain about developed market central banks, such as the US Federal Reserve, intentionally weakening their currencies through aggressive monetary policy.”

The aggressive moves by policy makers continue in 2015 with many foreign central banks looking to ease monetary policy, either by lowering interest rates or increasing the supply of money by purchasing government and private-sector bonds, an approach known as quantitative easing or QE. In an analogy similar to being the last person in a movie theater when a fire alarm is sounding, what central bank would choose not to intentionally devalue or weaken their currency if all of their trading partners have already done so? It is this recent trend of purposeful currency devaluation, designed mainly to boost trade that is central to the theme of currency war(s).

In a recent interview US Treasury Secretary Jack Lew suggested that “there is a very big difference between countries that use domestic tools for domestic purposes, macroeconomic tools to grow their economy which is something that in the world community we have agreed to and we in the United States have used. On the other hand, it is another thing to target your currencies for the purpose of gaining unfair trade advantage.”

Is having a weaker currency really a good thing?

In this long and grinding period of post-recession recovery, central banks are considering a varying list of means, both conventional and unconventional, in their fight to stimulate economic growth. Michelle Gibley, Director of International Research for Charles Schwab, recently wrote about three (3) benefits of having a weaker currency.

“Export growth. A country’s exports can gain market share as its goods get cheaper relative to goods priced in stronger currencies. The resulting increases in sales can boost economic growth and jobs, as well as increase corporate profits for companies that do business in foreign markets.

Rising inflation. Inflation can climb when economies import goods from countries with stronger currencies, since it takes more of a weak currency to buy the same amount of goods priced in a stronger currency. Currently, low economic growth has resulted in deflation becoming a bigger risk than inflation in many countries.

Relief for debtors. A weak currency can boost inflation, and therefore incomes and tax receipts, while the value of debt is unchanged, making it easier for local currency borrowers to pay down debts.”