September 17, 2012
The Federal Reserve and the European Central Bank’s new rounds of quantitative easing could herald a new era of “currency wars”, according to Bank of New York (BNY) Mellon research.
The dollar fell to a seven-month low against the yen and a four-month low against the euro last week after the Fed announced a new round of quantitative easing (QE3) on Thursday. Under the latest plan, the Fed will buy up $40 billion of mortgage-backed securities a month in order to stimulate the U.S. economy.
Adding insult to the greenback’s injury on Friday, the ratings agency Egan-Jones cut the U.S. sovereign rating to AA-minus from AA, saying the Fed’s QE3 would reduce the value of the dollar, rather than reduce national debt.
“The Fed’s QE3 will stoke the stock market and commodity prices, but in our opinion will hurt the U.S. economy and, by extension, credit quality,” the firm said.
Central banks such as Brazil and others around the globe are already moving to mitigate the effects of the “debasement” of the dollar by taking “measures to prevent excessive currency strength,” according to BNY Mellon.
Imposing capital controls is nothing new, BNY Mellon pointed out in a note, as many central banks instituted such policies to prevent their currencies from strengthening back in 2010 when the phrase “currency wars” was first coined by the Brazilian finance minister, Guido Mantega.
Back then, BNY Mellon said, there was broad consensus around capital controls by emerging and established economies such as Brazil, Colombia, Taiwan, South Africa and Russia, which endorsed by the IMF under the leadership of Dominique Strauss Kahn.
BNY Mellon notes that Brazil’s pre-emptive strike with capital controls in 2010 may have been premature, as in fact the Real is now “much weaker against the U.S. dollar.” It points out that other countries that resorted to such measures have also seen their currencies weaken substantially against the dollar.
Yet, despite that experience, says the firm, the potentially unlimited size of the Fed’s latest asset purchase program would likely prompt capital controls once again.
“We are about to witness the Fed’s most aggressive actions to date…the Fed has… replenished the punch bowl but neglected the fruit and is set to ladle out straight booze,” BNY Mellon states, adding that “ominously, the U.S. Dollar has already fallen by 3 percent this month.”
The current “coordinated global slowdown” will make emerging markets seek to protect themselves by making “pre-emptive moves to secure growth whilst they can,” the firm warns.
BNY Mellon predicts central bank action to fight dollar debasement won’t be restricted to emerging markets.
“The odds on the Japanese taking action to weaken the Japanese yen before month end have surely begun to shorten.”
After the yen reached its strongest level in seven month against the dollar on Thursday, the Japanese Finance Minister Jun Azumi hinted on Friday that the Bank of Japan would act swiftly to weaken the currency.