Quantitative easing, the new weapon of mass devaluation

A currency war is brewing, spurred by devaluation and inflation, the dangerous by-products of a near-zero interest rate environment, says Saxo Capital Markets.

Nick Beecroft, Senior Analyst at Saxo Capital Markets, comments:

"As the superpowers of this world flex their muscles for the control of financial assets through the setting of interest rates, loan and debt agreements to manage current account surpluses, this could develop into a financial time bomb in the foreign exchange market."

“Lowering interest rates can have an unwanted side effect of letting inflation rise. However, a country that has the ability to manage its fiscal and monetary policies well enough to keep growth on track, and at the same time keep goods and services relatively cheap for exporting, is likely to come out stronger of a currency war.”

In “Currency wars”, the fourth chapter of the e-book in Saxo Capital Markets’ FX Debates Series, Saxo observes the emergence of quantitative easing as the new ‘weapon of mass devaluation’.

Beecroft comments: “Historically, governments used to focus on both fiscal and monetary stimuli to devalue their currency in order to gain a competitive advantage on other economies. However, when interest rates hit rock bottom and taxes could no longer rise, quantitative easing became their main tool.

“The danger with monetary easing is that, just like tsunamis, no one knows where the water will hit first and what will be the long-term impact. The [fiscal] hole dug by quantitative easing may be so deep, that it may never be possible to rise back up to the surface again.

“The Fed’s’ unlimited QE3 has set a new paradigm in the war. What comes after unlimited, super unlimited? Other global FX power players include the Euro, tied together with the British Pound - the fate of Great Britain being closely intertwined with that of the Eurozone - followed by the Yen, Australian Dollar, Swiss Franc, Brazilian Real, Renminbi, as well as the Canadian Dollar and a host of minor and exotic currencies.”

On the Brazilian Real, Beecroft says: “Brazil has relied on using currency controls and fiscal policy on imports and exports in the last few years to stem speculation in the Brazilian Real. Letting go of some of these strings in the past has caused some predictable volatility in the currency. For traders, ‘the short term trend is your friend’ has been an important adage here.”

On the USD/CNY, Beecroft says: “In the US, the devaluation of the Dollar to help the country’s trade deficit has a real impact on the growth and job situation. It does play an important part in the domestic policy even if it is not explicitly discussed. If we cut directly to the central battlefield in the currency wars, China has been the elephant in the battle. Recent data suggests that the Chinese central bank will once again change its stance on the pace of devaluation in the Dollar-Renminbi rate, even if it is already at a limited pace.”

“Currency wars” is the fourth part of Saxo’s e-book, #FXdebates – Trading Insights from our Top Analysts. On March 13, 2013 Saxo will host an event, in collaboration with Bloomberg LINK, focussing on the outlook for FX in 2013 and beyond. For more information please see: http://uk.saxomarkets.com/fxdebates. Follow the debates via twitter: https://twitter.com/SaxoMarketsUK; Hashtag: #FXdebates