THE recent policy action of the Swiss National Bank (SNB) to release the Swiss franc from its exchange rate-lock to the Euro was followed by the European Central Bank (ECB) announcing its own money printing scheme. But somewhat hidden behind the screen was the fact that the SNB also lowered its base interest rates to a negative 0.75 percent.
All these moves are the natural progression of Keynesian economic policy that says the government and central banks must do everything possible to increase spending from all sources. If the government does not have enough money to spend to stimulate economic activity, then it must print new currency. If businesses are not willing to borrow money to spend, then set interest rates as artificially low a level as possible. If consumers will not spend, then make deposit rates negative to make saving money incur a financial penalty.
The idea is to make holding cash as financially painful as possible.
While normal people with common sense think that having a cash reserve is both prudent and beneficial, the ‘new normal’ is the opposite. The ‘old normal’ is that a nation’s currency exchange rate should be determined by trade flows. Now our modern economic wizards have decided that trade flows should be determined by the currency exchange rates.
The model for export businesses used to be that a company takes local raw materials and turns it into a value-added product for export. If your nation had abundant iron ore, then it should make steel for domestic use and possibly export.
But a decade or so ago, China changed the model by selling products not because they were better but only because they could sell at a cheaper price by manipulating the currency exchange rate. Europe and the US should have done everything up to and possibly including declaring war against China to save their industries. But China sweetened the deal by loaning back any profits they made on their exports to allow the West to “Buy Chinese” without actually having to pay for the goods.
In the 21st century, as I have said repeatedly, it is all about the currency.
The recent move by the ECB has instantly pushed the exchange rate of the Euro to the US dollar to a low not seen since 2003. The important thing to remember is nothing has changed in the past week with regard to trade flows to affect the rate. It is only about government policy and interest rates.
Money is flowing into US dollars because you can actually get paid a little interest loaning your money to the US government and to US banks, unlike in Denmark, Switzerland, and other Euro currency countries. Some other countries still have positive rates like bankrupt Greece and nearly bankrupt Spain. So the US dollar is growing stronger because of its positive interest rates, but the question is, for how much longer?
A strong US dollar is bad news for the US for three reasons. American exports are getting more expensive in the global markets potentially reducing US economic growth. US imports are cheaper reducing the inflation that the US Federal Reserve is so desperately trying to make happen. Money flowing into the US increases the probability of asset price bubbles. Further, a stronger dollar takes a sooner-rather-than-later interest rate increase off the table.
To attack a strong dollar, the Federal Reserve has only one option left: negative interest rates.
To do this, the Fed would first start charging negative interest rates on bank reserve accounts, which then will go through the system and result in negative interest rates on savings at banks.
We have progressed to the next phase of the global currency wars in spite of the fact that US officials have said all along that there is no currency war. The global financial markets would disagree especially those foreign exchange trading companies and their clients that just died due to the Swiss franc appreciation.
Meanwhile in the last sane economic zone on the planet, Asean nations still believe that cash money should keep its value, pay real interest on loans, and strive for stable currency exchange rates determined by market forces.
If the US does “go negative,” the sound you hear will be massive investment flowing to countries like the Philippines as never before.
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