Currency war feared after EU cuts rates

The euro slid by 1.5 per cent after the European Central Bank cut a key interest rate last week, saying it hoped to stimulate the economy and head off deflation.

The U.S. is more than two years into a program of quantitative easing without a sign of tapering and now more countries are moving to deflate the value of their currency, among them New Zealand, Australia, the Czech Republic and Japan.

James Rickards, an advisor to the White House and the Pentagon, believes it’s the start of a new currency war.

Central banks have to avoid deflation at all costs and that’s really what they’re worried about. They’re worried about it in Europe, the U.K., the U.S. and all over the world- James Rickards

“We’re not always in a currency war, but when they start they can go on for a very long period of time. They can go on for five or 10 or 15 years. They’re not over quickly. The reason they’re not over quickly is that there is no natural resolution,” he said in a recent interview with CBC’s Lang and O’Leary Exchange.

“As soon as one country, particularly the U.S. which started the global currency wars in 2010, tries to cheapen its currency, then other countries retaliate. Some of them cheapen a currency by cutting rates, but others can always put up import duties, capital controls and other techniques they can use to fight the currency war.”

The ECB cut its main refinancing rate to 0.25 per cent,  held the deposit rate it pays on bank deposits at 0.0 per cent and cut its marginal lending facility — or emergency borrowing rate — by 0.25 per cent to 0.75 per cent. 

The Eurozone economies remain fragile, barely growing after two years of recession. But the real fear is deflation, Rickards said, because it would leave the debt-to-GDP ratio of these countries in a danger zone.

Central banks and debt

“Central banks have to avoid deflation at all costs and that’s really what they’re worried about. They’re worried about it in Europe, the U.K., the U.S. and all over the world.  This would really make the sovereign debt crisis far worse that what we saw in 2010 and 2011,” said Rickards, who is author of Currency Wars: The Making of the Next Global Crisis.

At the G20 meeting two months ago, members pledged to “refrain from competitive devaluation.”

But the euro's fall has left many countries worried about their exports.

The Czech central bank began selling its own currency last week, forcing the koruna down by 4.4 per cent against the euro.

Peru’s central bank cut borrowing costs on Nov. 4 for the first time in four years, citing slow export growth.

New Zealand’s central bank has delayed expected rate hikes and Australia’s Reserve Bank chairman says its currency is overvalued and it may be forced to cut rates.

The Bank of Japan cut rates six months ago, but is still struggling to meet its inflation targets. Rickards believes the yen may sink as low as 110 to the US dollar.

Rickards said cutting rates is the wrong way to boost export growth and stimulate economies.

Back off on stimulus, Rickards says

“You don’t promote exports with a cheaper currency. You promote exports with value added,” he said.

“Look at Singapore and Germany, which have had very successful export records for decades, with relatively strong currency. They promote exports with technology, innovation, value-added – in other words, with great products.”

He believes the U.S. program of quantitative easing, which involves the Fed buying $85 billion of U.S. bonds each month, is a mistake.  

The policy is not stimulating growth, he said. Instead labour participation is dropping and inflation is low and economic growth is anemic.

Besides putting impetus into a currency war, the Fed stimulus program has contributed to a bubble in stock markets, Richards said.

“The thing about bubbles – they tend to run a lot longer than you expect and they pop at the most unexpected times, so you ask me when it’s ready to pop – whether it’s the beginning of next year, late next year – I don’t know.”