Currency wars are back on for many countries around the world. The theory is that by significantly weakening its currency, a country can spur economic activity, making its products and services attractive for export, thus stoking growth and jump-starting employment.
The tool in favor is QE, or quantitative easing, namely printing money. The practice was tried by Japan in 2001 and popularized in 2008 by the US Federal Reserve, chiefly to address persistently high unemployment in the US labor market.
In 2014, the Economist pointed out the jury is still out on QE. Among the worries: “the flood of cash has encouraged reckless financial behavior and directed a fire hose of money to emerging economies that cannot manage the cash” and recovery will be temporary until “central banks sell the assets they have accumulated.”
Meanwhile, a rapidly appreciating dollar is causing havoc for many emerging economies in paying back dollar-denominated debts. For big oil producers amid falling oil prices, as in Russia, Nigeria and Venezuela, the markets can force devaluation or depreciation through currency flight. Foreign investment leaves, and the local currency loses collateral backing for hard currency reserves held by central banks which must then be sold.
Holistically, cheaper currencies mean cheaper labor costs, leading to cheaper exports and overall lower costs of doing business domestically with locally produced inputs. This aspect is highlighted in Indonesia, Malaysia and India with their recent depreciations. This would be fine if countries in 2015 operated alone economically, but they don’t. National economies are all interlinked.
Weakening currencies, for any reason, do carry real costs: to a country’s citizens, especially if they rely on imported foodstuffs, pharmaceuticals, energy and technology. As most of these products are priced in dollars, the world’s so-called “reference” currency, consumers can experience ascending price shocks, sometimes on a daily level, such as in Argentina, Venezuela or Ukraine.
With social media and the internet, central banks instantaneously telegraph their intentions to the markets.
Only 15 years ago, central bankers would announce currency devaluations late on Fridays, after markets had closed, with citizens awakening on Monday to find their bank accounts depleted of real value. With devaluation ongoing in Russia with the ruble and pending devaluation with a possible Greek exit from the European Union and return to the drachma, citizens have been rushing to remove savings from bank accounts, converting what holdings they have into dollars or more stable currencies like Swiss francs and euros. No one wants to be left holding a devalued currency and depositors seek safe havens for their wealth.
The internet and new media awareness are driving much of this pandemonium, leading to larger macroeconomic ramifications in our interconnected world. If citizens can collect their money, sending it out of country before the devaluation occurs, these actions in and of themselves may weaken monetary policy.
For example, so many depositors pulled money out of Russia, converting rubles to dollars and euros, the Russian currency’s value plunged, from roughly 35:1 to approximately 61:1. Russia tried to thwart the pullout, raising interbank lending rates and avoiding currency controls. Russians nonetheless, were not convinced.
Perhaps the most egregious examples of currency devaluation driven by social media are in Venezuela and Argentina. Venezuela has multiple exchange rates: the official CENCOEX rate (6:1); SICAD I (12:1); a weekly auction rate, SICAD II (52:1), a foreign investor rate; and a black-market rate (200:1). Recently, SICAD II was allowed to float freely, effectively a government devaluation but with only a tiny amount of dollars available. The exchange rate immediately jumped to 172:1, recently topping 200:1!
The gimmickry fools no one. Long lines have formed. People cannot buy basics, and imports are prohibitively costly. Foreign airlines operating in Venezuela face mounting losses on ticket sales and have suspended flights. The experiment with Chavez-style economic Marxism, relying on the price of one commodity, oil, has failed. The legacy is economic insecurity, street violence and food shortages.
Argentina has suffered a similar fate with its devalued peso, exacerbated by default in July. Argentina’s exchange rate at the start of 2010 was 4:1 and since then has halved to an official rate of 8:1, As Argentines rely heavily on dollars for commercial transactions, a black-market dollar market called the “blue dollar” has emerged, currently around 14:1.
In the cases of Russia, Venezuela and Argentina, cheaper currencies brought misery. Central bankers have not contained the damage as the troubles are detailed on social media including Facebook, Twitter, economic forums and travel sites. Social-media sites proscribe all types of remedies and avoidances for citizens seeking to withdraw funds, obtain dollars at good rates, avoid governmental controls and even fake money.
Conversely, the world of economic information has also created another demand for safe havens. Traditionally, the US dollar has been the currency of choice, but past years of near zero interest rates and an $18 trillion public deficit are testing this status.
People seek out currencies backed by economies with strong balance sheets, high exports, small populations, and above all, social stability. The Hong Kong dollar, Danish kroner and Swiss franc stand out.
This has not escaped notice of central banks. Buying of strong currencies contributes to upward appreciation and the possibility that country’s goods and services may become non-competitive and costly. The remedy in part is a currency peg, which linking the value of that currency to another, usually that of a larger trading partner. Hong Kong pegs its dollar to the US dollar at a rate of 7.8:1; Denmark to the euro at a rate of 7.45:1, and until last month, the Swiss franc had a ceiling against the euro of 1.20:1.
The Swiss abruptly released the peg in mid-January. Within moments, the franc’s value soared by 13.5 percent against the euro, putting the markets into turmoil and wiping out many investor positions banking on a weakening franc due to the quantitative easing proclamations of EU Central Bank Chairman Mario Draghi.
The Swiss National Bank, SNB, scrapped the peg as to continue buying a devaluing euro no longer made economic sense, and had to move secretly due to instantaneous communication. The bank had little choice. Quietly signaling intentions beforehand may have benefitted some well-positioned investors more than others, creating a market bias but with the same result.
Further, the Swiss and Danish central banks have now imposed negative interest rates to stem the tide of those seeking safe refuge for their money. Commercial deposits in those country’s banks will be charged yearly interest fees – 0.50 percent in Denmark and 0.75 percent in Switzerland. These countries are adamant – no longer want a tide of foreign money inflating their small economies exchange rates.
News of currency strengths and weakness is transferred immediately.
Central banks can no longer surprise the markets, and their Draconian actions affect investors and ordinary citizens alike. No nation has devalued its way to prosperity, nor can countries keep hot money inflows out if investors perceive a safe haven in a sea of volatility. With social media and instantaneous economic information, there is no going back to the old days a gradual flow of news and sense of panic. Central bankers must create a currency playbook that promotes a steady hand and public confidence rather than intrigue.
Will Hickey is associate professor and capability advisor for the School of Government and Public Policy in Indonesia. This was written for YaleGlobal, the website of the Yale University Center for the Study of Gobalization