It's war in the currency markets

It also had a double effect of driving up the currency values of the BRICS countries, undermining their competitiveness and also fuelling asset bubbles. The BRICS were frustrated with the money printing programmes of the Fed and the Bank of England, which poured out 375 billion pounds sterling. The BRICS countries’ holdings of US Treasuries also fell in value with the cheaper dollar.

Now, QE 3, or “QE Infinity”, is churning out US$85 billion a month, flooding the world with cheap credit at an almost zero per cent interest rate. The past five years has seen the Fed expanding its balance sheet from $800 billion to $3.4 trillion. By the end of this year, that will swell to $4 trillion.

The world’s financial markets have experienced unprecedented bubbles. The BRICS nations earlier this year met in South Africa to draw up a blueprint to kill the US dollar as the world’s reserve currency. They planned to establish a development bank, modelled after the World Bank. They want a new financial order. China, in particular, would like to exert more influence on the global scene with the planned internationalisation of its yuan. 

Japan followed up Currency War 2 with a strategy to reflate its economy by planning to print $1.4 trillion, equivalent to 25 per cent of its GDP. Financial asset bubbles went crazy. The policy coordination between the Bank of England, the US Fed, and the Bank of Japan has been well camouflaged. Upon closer examination, the three central banks dance to the same tune. The European Central Bank, at the same time, has its hands tied to tighter European regulations, with Germany opposing strongly against any monetary mischief. 

May 21 saw a dramatic turn of the tide. Ben Bernanke, the US Fed chairman, told Congress that the Fed planned to taper QE if the US economy recovered as projected. Last Wednesday, following the meeting of the Fed Open Market Committee, Bernanke came out with a similar message. Ever since, there has been panic selling of all asset classes. The bond market suffered a rout. Stock markets crashed. The BRICS and emerging-market currencies plummeted. 

Economic growth projections have been revised downward. The Thai market has also taken a big hit. The mainstream media suddenly gave the BRICS nations a bad press. A sell-off has crashed China’s stock by 20 per cent. The interbank market faced a sudden liquidity squeeze, driving up the short-term rate to 25 per cent. The People’s Bank of China had to come to the rescue. But it waited until the 11th hour to do so, in order to teach the banks, which had too much exposure to shadow banking, a dear lesson. 

China’s growth has been revised downward. Brazil is facing mass protests, threatening the stability of the government. Brazil was the first country to issue a complaint against QE, saying that it represented a currency war, which drove up the value of the real. Now the real has gone into reverse, with a falling value, and the Brazilian economy faces higher inflation. The central bank was forced to remove its capital controls. When the government announced that it would raise transport fares, the people took to the streets.

South Africa has also faced a sharp fall of its currency value. India’s rupee has breached the 60 per dollar mark to record a record low. Only Russia appears to be weathering the financial storm on a firmer footing than the other BRICS. Apart from confronting the Western powers in Syria, Russia is also facing off with the US over Edward Snowden, wanted for his tell-it-all story of the US National Security Agency snooping on phones and the Internet.

The Bank for International Settlements, dubbed the “central bank of central banks”, has signalled a need for central banks to withdraw monetary stimulus in favour of further economic restructuring. This is the final nail in the coffin. Capital, which so far has fuelled the asset bubbles, is set to head into reverse. Interest rates are shooting up. Economic growth can only head downward. The crisis in Europe deepens, as evidenced by renewed spikes in bond yields.

But for how long can the global financial centres – London and New York – play this liquidity game. When they print money, asset bubbles form. With they withdraw money printing, asset prices collapse. The Dow Jones is saved for now. The US dollar has become a darling again. But the US can’t be an oasis of stability if the BRICS and other countries are hurt badly. And the risk of higher bond yields has exposed the bond market bubbles. We have to see how the BRICS and emerging markets adjust to the reversal of capital flow. The BRICS obviously will have to fight back. But the financial centres are not going to give up their power easily. We can expect to see an intensified currency war ahead.