In the world of central banking, the gloves are coming off. You can blame the Japanese.
At the G7 meeting this weekend, everyone smiled politely and said that they completely understood why the Japanese were printing unprecedented amounts of money and hammering the yen.
The main reason they gave Japan a free pass is because lots of other countries are hoping to get away with doing the same.
Central banks overseeing around a quarter of the world’s GDP have cut rates this month alone, notes Bloomberg.
The currency wars are just getting started…
The Bank of Israel joins the currency wars
The Bank of Israel has become the latest central bank to cut interest rates. Yesterday, the bank cut the key interest rate by a quarter of a percentage point to 1.5%. That’s a three-year low.
What was unusual is that the rate cut came outside of an official bank meeting. That meant it surprised the market, which sent the shekel down and Israeli stocks higher.
So why did they do it? Bank governor Stanley Fischer threw out a variety of excuses.
He told Bloomberg that the move came “in light of the continued appreciation of the shekel, taking into account the start of natural gas production from the Tamar gas field, interest rate reductions by many central banks – notably the European Central Bank, the quantitative easing in major economies worldwide and the downward revision in global growth forecasts.”
But clearly it boils down to this: if everyone else is going to print money, slash rates, and hammer their currency, then we’ve got to join in.
As Bloomberg points out, the shekel has risen by nearly 9% over the past six months. It’s one of the best-performing currencies in the world, after the Mexican peso.
Trouble is, “exports make up about 40% of Israel’s economy.” That means the Israeli economy really won’t like a rising currency. It doesn’t help that sales of natural gas will turn the shekel into a form of ‘petrocurrency’.
So the central bank also plans to buy around $2.1bn in foreign currencies (selling the shekel to do so), to offset the impact of natural gas exports.
That all sounds quite sensible. But there’s a flipside to cutting interest rates.
You see, we’ve all become really quite blasé about rate cuts. There seem to be no consequences these days (well, beyond surging stock markets at least). Much of the world has been in such a deep hole that it was hard to see whether or not all that money-printing and rate-slashing was having an impact.
But in Israel, the trade-off is more visible. The country already has a very buoyant property market, with prices up by around a fifth since 2010. Back in November, the central bank set restrictions on the amount buyers could borrow to purchase a house. First time buyers need at least a 25% deposit.
It’s hardly ideal to have your central bank trying to control a bubble with one hand while stoking the fire with the other.
Politicians are leaning too much on central bankers
It also reveals just how much power central banks have. Politicians have virtually ceded responsibility for their economies to the central bankers.
The politicians may fiddle with the national balance sheets: tweaking a regulation here and there, diverting handouts from one special interest group to more politically-friendly ones. But overall, the burden of returning economies to growth is falling on central banks.
This is nice for politicians, in that they can blame central bank policy if things go wrong. But it does not sit well with the central banks’ role as the ‘guardian’ of a nation’s currency. After all, the only real lever they have to pull to boost growth is to cut interest rates.
And with Japan’s experiment apparently working so well – in that stocks have rocketed – the pressure on central banks to follow suit will only continue.
What does it mean for your money? Well, we’d expect the flood of money from central banks to continue. In turn, we’d stick with investing in those stock markets most likely to benefit – the cheap ones. We’d stick with Japan and the eurozone.
As for the US, in a world where everyone is printing money, it’s going to be hard for Ben Bernanke to keep devaluing the dollar. Everyone is getting excited about the idea that the Fed might rein in quantitative easing (QE). That seems unlikely to us.
But even if QE is simply maintained at current levels, that’s not going to look that impressive if the rest of the world’s central banks are competing to do various ‘shock and awe’ currency debasement schemes. So we reckon the US dollar is the currency most likely to benefit from this ‘race to the bottom’ for now.
I’ll be looking at the currency wars and the fallout in more detail in this week’s issue of MoneyWeek magazine. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
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