Recently the European Central Bank cut its key rate in a surprise decision some investors say was intended in part to curb the euro after it soared to the strongest since 2011. The same day, Czech policy makers said they were intervening in the currency market for the first time in 11 years to weaken the koruna. New Zealand may delay rate increases to temper its dollar. To top it off Australia warned the Aussie is “uncomfortably high.”
Actions from the central banks is throwing more fuel on the fire causing the currency wars to heat up. This move comes barely two months after the Group of 20 nations pledged to “refrain from competitive devaluation” because of its destabilizing effect. With inflation slowing and the outlook for the economy being downgraded by the International Monetary Fund countries and central banks seem to be revisiting policies that tend to boost competitiveness through weaker currencies.
The polices of lower interest rates and pumping money into the system has not created as much growth as hoped but it has brought with it major market distortions. Money has resisted flowing into the things that would bring a recovery and have flowed into the stock markets, financials, and areas of speculation. Welcome to the world of the "global economy" where open borders dilute efforts to concentrate policies to a specific area. Cross border flows cause such efforts to produce results similar to pouring water into a leaking bucket.
One of the main reasons the stock market has benefited is that it is highly liquid and easy to enter and exit. Unlike real estate that has a high bar of entry with many fees and often taking months or even years to sell, stocks can be exited in a blink of an eye. This is a big advantage in uncertain times when valuations can change rather quickly. The wild card in this is inflation. Currently velocity (the speed at which money flows through the economy) is very low but if it rapidly increases more money will be chasing the same amount of goods resulting in more inflation.
The danger is that once inflation takes root it can take on a life of its own and feed on itself creating a hard to control cycle. How the central banks can get off this fence is the issue and if it can be done in a safe manner is yet to be determined. One thing is clear, we cannot remain on this artificial growth path forever. We have seen much of the effect wear off from prior bouts of easing, in the past each wave acted as a tailwind pushing us towards recovery. Now as central banks begin to taper and resume more normal policies many economist fear this will become a major drag on the economy going forward.
Footnote; As always your comments are welcome and encouraged. In a separate post I chronicle the 10 most pressing and important problems facing our world, these are increasingly more menacing in that we live in a rapidly changing world that gives us little time and less room to react and set straight the mistakes of our past. The link can be found below,