In a much-anticipated move last Thursday, ECB President Mario Draghi announced another set of monetary measures designed to reinvigorate the eurozone’s economic recovery—including a bond-buying program many call quantitative easing (QE). The euro responded by hitting a 14-month low, leading some to think a weaker currency is Draghi’s ulterior motive—and bond buying is his shot in an often-feared, rarely seen “currency war.” But a currency war requires two participants, something that hasn’t happened over this expansion despite frequent worries—and considering a weak currency isn’t an economic panacea, it’s tough to imagine this time going any different.
Ostensibly, the ECB’s goal is to get money moving again. The bank cut its three main interest rates by 10 basis points, bringing the central bank deposit rate to -0.20%. Theoretically, charging banks to hold excess reserves at the ECB is supposed to stimulate lending, consumption and business expansion. But the rate has been negative for three months, and banks have simply shifted reserves to higher-yielding assets while continuing deleveraging.[i] Tiny rate tweaks likely won’t move the needle—which Draghi admitted, explaining the move was a technicality to bring all rates to their lower bound—ergo, bond buying, amount TBD, beginning in October and focusing on asset-backed securities (ABS) and euro-denominated covered bonds (debt backed by cash flows from loans held by the issuing bank).[ii] Draghi hasn’t called it QE, and unlike traditional QE, the ECB won’t buy government bonds, but the resemblance is striking, and the theoretical goal—boosting banks’ liquidity and lowering businesses’ and consumers’ borrowing costs—is the same.
However, others argue Draghi’s stated objective is a smoke screen, claiming this is actually a competitive devaluation, or more colloquially, a “currency war.” They claim Draghi wants to race other nations to get the (perceived!) weak currency edge in exports.
When considering currency wars, it is worth pondering the question: Who wins? A weaker currency doesn’t automatically equal a better economy. Take Spain—with a strong euro, Spanish exports have set repeated highs, boosting growth. In Japan, the BoJ “succeeded” in weakening the yen with QE beginning in April 2013. But in the period since, Japan’s exports in yen are up a meager 6.8%, an inflated figure itself: export volumes are down. One thing the weak yen has stimulated? Rising import costs like energy prices, a big drag on corporate profitability. This highlights one of the major flaws of the notion countries “win” with weak currencies: In a globalized world, a country usually can’t increase exports without imports rising. Most major products have inputs sourced from abroad at some point in their life cycle. A weaker currency makes those imports more expensive. Pursuing a policy targeting more exports favors one portion of the economy but hurts others. It may even favor one input to a company’s bottom line (sales) over another (costs).
There is also no guarantee the ECB’s latest initiatives weaken the euro for a meaningful period. Take US QE—relative to a trade-weighted basket of currencies, the dollar fell only in the very short term when QE2 was announced. The dollar overall rose through Operation Twist, QE3 and QE-infinity. Markets price in policies quickly—and, since currencies always trade in pairs, other nations’ policies matter, too.
When you consider other countries’ policies, we’re betting it’s clear there is no currency war afoot, in any meaningful sense. Japan’s outright declaration they’d seek a weaker yen didn’t lead to Taiwan or Korea—Japan’s biggest regional competition—declaring war, currency or other. Neither attempted to weaken their currencies in 2013, and both saw trade rise—Taiwan’s and Korea’s exports rose +1.4% and +2.2% in 2013, respectively. While Japan sought to weaken, the UK and US began dialing back QE—either abetting Japan’s efforts to weaken or opting out of this supposed spat. Those two nations are at the forefront of developed world growth rates over that span.
Ultimately, whether the ECB is firing a shot in a currency war isn’t really a relevant question. It’s more pertinent to ask whether any of these policies are likely to reverse some of the roughly €4 trillion in bank deleveraging that’s taken place in the last few years. If it’s anything like QE elsewhere, it will weigh on long-term rates, which ultimately decreases banks’ profit margins. That, coupled with the looming stress tests—the major reason for tepid lending of late—will likely further bog down lending. The better fix for that problem is to get through with the eurozone’s stress tests. Quasi-QE is a modest negative for the eurozone, but it doesn’t seem likely to upend to the positive factors behind this global bull.
[i] Eurozone banks have deleveraged to the tune of roughly €4 trillion over the past few years, and subtracting roughly four Italys worth of loans isn’t exactly economic stimulus.
[ii] Some speculate it’ll be €1 trillion, based on Draghi’s stated desire for the ECB’s balance sheet to reach 2012 levels. Subtract the current figure from the 2012’s and, voila! €1 trillion. But this ignores the Long Term Refinancing Operations (LTROs), Targeted-LTROs and the end of the ECB’s Securities Market Program sterilization, all of which are slated to add hundreds of billions to the balance sheet. Europe’s ABS market is also vastly under €1 trillion. Some argue the ECB’s program will encourage the ABS market to grow, but it seems weird for them to bank on this.