SHADES OF THE GREAT DEPRESSION OF THE 1930s: a race to less than zero
[interest rates] with central bank easings
The foreign exchange markets are beginning to look like a battlefield
wherein is occurring a war of competitive depreciation involving a number of
national and regional currencies. Can a Smoot-Hawley type tariff war be
far behind? Perhaps it has already
begun. The European Central Bank
pressured interest rates on deposits refinancing rates into negative territory
Less than Zero
When Interest Rates go Negative
March 4, 2015 Http://www.bloombergview.com/quicktake/negative-interest-rates
We are witnessing just the overture to such a war which began with a
series of actions by central banks to depreciate their currencies and a return
series of salvos by other nations retaliating to offset the initial actions.
GDP: 5% in Third Quarter 2014; 2.2% in the Fourth
Initial evidence of the impact in currency appreciation can be found in
the most recent Gross Domestic Product data which in the case of the U.S. estimates
the quarterly growth rate of real GDP which was reduced by around 2 percentage points. From the third quarter to the fourth quarter
2014, Net Exports (Exports – Imports) fell by 1.9%, going from 0.78% to -1.115%.
With slowing economic growth rates and even
recessions looming for some nations, can “Beggar Thy Neighbor” become an increasing practice by them? Time will tell if history is repeating
So what’s the
Downside to a Strong Dollar?
For those not well versed in this area, if the U.S. Dollar appreciates (grows
stronger) against the currencies of its trading partners’ (the same as saying
that if the currencies of its trading partners depreciates against the Dollar,
since they are reciprocals of each other), U.S. imports of goods and services
will tend to increase because the Dollar price of those foreign goods and
services are now cheaper than before the change in the exchange rate. At the same time, U.S. goods and services
become more expensive to our trading partners since the foreign currency prices
of U.S. goods and services have increased.
Recall that imports tend to depress the domestic level of economic
activity of the importing nation while exports tend to raise the level of
economic activity of the exporting nation.
One of the four components of a nation’s Aggregate Demand (AD) is Net
Exports of Goods or merchandise and services (Exports minus Imports).
Neighbor: Depreciation is Underway – a Tale of Quantitative Easing the World
In the 1930s, such tactics as depreciating one’s currency and raising import
tariffs were referred to as “Beggar thy Neighbor” policies. It is a major reason why international trade
virtually came to a halt in the early 1930s and helped lengthen the Depression,
providing ammunition for extremist movements such as fascism and communism.
There is no doubt that a number of regions have either begun to
experience economic weakness or are continuing in the doldrums. Added to this growing problem was what some
might call a spirit of optimism. But I call it wishful thinking at best or
jawboning at worst by various public officials; including high ranking
officials of the Federal Reserve System, that the worst was over and the FED
could end its policy of Quantitative Easing.
Concurrently, high ranking officials of the central banks of other
nations including the European Union’s central bank (ECB) continue to pursue
their own policies of quantitative easing.
The effect of the latest quantitative easing ending (QEs) in the U.S.
while beginning in many other regions of the world, meant that downward
pressure on interest rates would occur in those nations adopting QE and at
best, interest rates holding steady if not beginning an ascending pattern in
the U.S. This tends to cause a flight to
the Dollar because of higher relative yields as well as a flight to quality and
the U.S. Dollar. The net result is the
appreciation of the Dollar brought on by bolder and more retaliatory policies by
other countries moving further down the path toward “Beggaring Thy Neighbor”.
Dollar Advocates Beware
Those advocating a “strong” Dollar, beware of the coming “Ides of
March”. A strong Dollar or the
appreciation of the Dollar leads to a rise in U.S. imports and a fall in U.S.
exports. An existing trade surplus in the U.S. Trade Balance will shrink or an
existing Trade Deficit will increase.
Either reduces the aggregate demand (AD) of the U.S. economy and tends
to reduce the growth rate of real GDP. As
the saying goes, be careful of what you wish for, as your wish may be granted.
the Ongoing Fallout from Currency Depreciation
In the following graphs we will depict various foreign currency
relationships with the U.S. Dollar.
The first will be a historical look going back to 2006 and the second
is a look at the last six months (October 2014 through February 2015). For the Chinese Yuan, we have a chart going
back to the 1980s as well depicting the deliberate plan to devalue the Yuan
versus the U.S. Dollar…witness the Chinese miracle (not unlike the Japanese and
German miracles that preceded it)