World Risk Developments October 2010: Spotlight on QE2, currency wars and the slowing world economy
The October issue of EFIC’s newsletter, World Risk Developments, examines the slowdown currently underway in the world economy. According to EFIC chief economist Roger Donnelly that slowdown is straining international economic cooperation and threatening an increase in ‘exchange rate protectionism’ as well as trade protectionism.
Many economies are losing steam in the second half of 2010, Donnelly notes, as the temporary spurs of inventory accumulation and fiscal stimulus that boosted them in the first half inevitably fade. Meanwhile, core inflation in the G3 – the US, eurozone and Japan – continues to fall towards zero.
To revive growth, the Bank of Japan lowered its policy rate to zero earlier this month. Along with the Federal Reserve and Bank of England, it has also recently begun to talk about the possible need for a second round of 'quantitative easing’, or ‘QE2’. This entails central banks buying long-term public and private financial assets with newly printed money. This ‘liquefies’ private sector balance sheets and put downward pressure on long-term asset yields and exchange rates.
Donnelly notes that the possibility of a QE2-led flood of liquidity into world financial and currency markets has spurred capital inflows into a range of emerging markets, as well as Japan and Switzerland. The central banks of these countries, led by China, have responded by intervening heavily in currency markets to stem the resultant appreciation pressures – pressures that could damage export growth. In Korea, Brazil and Thailand, governments have also been either imposing or increasing taxes on capital inflows with the same aim of weakening their currencies.
Recriminations have accompanied these policy responses and counter-responses. Washington accuses Beijing of keeping the renminbi 'significantly undervalued’. The US Congress has threatened to legislate countervailing duties to be placed on Chinese goods if China persists with its undervaluation. Beijing responds that Washington is following irresponsible monetary and fiscal policies. Tokyo has added its voice recently, urging Beijing and Seoul to 'act responsibly' on exchange rates. Brazil’s finance minister recently called these interventions in currency markets to keep exchange rates competitive and stem capital inflow an ‘international currency war’.
According to Donnelly, the attempts by China and other countries to keep their currencies down against the US dollar threaten to obstruct the rebalancing the world economy needs to undergo to achieve sustained growth. As he explains, ‘That rebalancing entails 'shopping nations' such as the US, UK, Spain and Greece 'shopping less and shipping more', and ‘shipping nations’ ‘shipping less and shopping more'. However, shopping and shipping nations alike now want to ship more; in other words, spur export-led growth through competitive currency interventions. This increases the risk that struggling economies like the US will take protectionist steps to shield their industries from foreign competition.’
In other stories the newsletter looks at: new IMF forecasts, emerging market FDI, the Brazilian presidential election, the improving oil industry outlook in Nigeria, and further nationalisations in Venezuela.