IT IS NOW apparent that over the past decade, central bankers have done a pretty bad job. By injecting huge amounts of liquidity into the system, they have kept alive bad banks, failed to ignite growth, caused major distortions (low interest rates and stock-market bubbles are the tip of the iceberg) and allowed governments to accumulate large debts, writes World Review Expert Professor Enrico Colombatto.
The world is not on the verge of catastrophe, but the illusion of damage control afforded by easy money and cheap debt service leading to even easier money and bigger fiscal imbalances will cost us dearly.
Policymakers worldwide do not seem to be following a strategy. It is therefore not surprising that one of the characteristic features of the current situation is uncertainty. True, most observers have realized that the different versions of quantitative easing have been largely ineffective, when not counterproductive. Yet they are at a loss to guess what might happen if QE were discontinued and monetary neutrality became the name of the game.
As a result, markets follow each word pronounced by the world’s leading central bankers with deep apprehension. Exchange rate forecasts diverge in all directions, wreaking havoc on the strategic decisions of companies and entrepreneurs. Within this context, future exchange rate developments will be dominated by the interaction of three scenarios: 1) how the U.S. Federal Reserve (Fed) reacts to the disappointing performance of the American economy, 2) to what extent the Chinese authorities make use of the yuan to revive the manufacturing sector, and 3) the perceived risk that the European Monetary Union will unravel. The one thing traders are certain about is what the European Central Bank will do: keep on providing easy money, regardless of the consequences for capital markets, savings and public debt.
As to the first scenario, the Fed is well aware of the distortions created by an expansionary monetary policy, but it is still persuaded that easy money remains necessary to spur satisfactory growth. Unless gross domestic product expands by at least 2.5 percent on an annual basis (the current rate is about 2 percent and weakening), U.S. interest rates will stay put.
Since most investors had been expecting a gradual tightening of monetary policy during 2016, slower growth will induce them to revise their expectations and sell dollars. If that happens, the greenback will depreciate, regardless of what happens in the rest of the world. This tendency was already palpable in early February and may continue through the year.
The dollar thus appears headed for considerable volatility, especially if the next few months’ data on the real economy send out mixed signals and are subject to numerous revisions and corrections. The volatility will only intensify if Fed Chair Janet Yellen hesitates and appears vulnerable to market or political pressures in an election year. In that case, the dollar could lose its safe-haven status.
In the medium term, the chances that robust GDP growth will underpin a strong dollar are modest. The U.S. recovery reached its peak in early 2015 and then lost momentum. As a result, Ms. Yellen’s resolve to put an end to easy credit also weakened. It is difficult to say how far the dollar could fall, but a 5-percent depreciation by June is not out of the question. This will be good news for many dollar-denominated debtors. European leaders hoping for a weak euro to enhance exports will not be pleased, however.
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Publication Date:
Mon, 2016-02-29 06:00
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