So much happened during last week that it is hard to know where to begin. One of my friends put a comment on his Facebook page that the carnage has commenced and another friend said that the entertainment has just begun. So many would be commenting on the US debt downgrade that Bare Talk would like to steer clear of it after noting that criticisms of the credit rating agency for the downgrade—after having contributed to the global crisis actually with their rating (non-) actions up to 2008—actually miss the point.
We shall focus on what the Swiss National Bank (SNB) and the Bank of Japan (BoJ) did last week. They both signalled a lack of patience with their currencies appreciating relentlessly. One friend said that their decision to intervene was tactical and that the two countries were comfortable at a strategic level—right or wrong—with the appreciation of their currencies. He may well have a point. After all, the Swiss franc had gained more than 20% against the US dollar this year before SNB chose to intervene.
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According to Reuters, “SNB cut its interest rate target band on Wednesday in an unflagged move to stem the rapid rise of the Swiss franc, adding it would take further measures if necessary. SNB narrowed its target range for the three-month Libor interbank rate to 0.00-0.25% from 0.00-0.75 %, and said it would very significantly increase the supply of francs to the money market over the next few days.”
Then, on Thursday, on the back of intervention by the ministry of finance in Japan to weaken the yen, BoJ decided to increase its asset purchase programme to 50 trillion yen from 40 trillion yen. That increment is approximately $125 billion. It is not small. Part of its decision is based on recent yen strength and part of it on the expectation that revisions to the Consumer Price Index would further entrench deflation in Japan.
Switzerland and Japan are used to seeing their currencies appreciate steadily against the dollar over the years. But the pace of appreciation has accelerated lately and that might be painful for their economies in the short term.
Hence, it is unsurprising that they have begun to draw a line in the sand against further currency appreciation. However, they might only meet with limited success. The US economy is losing momentum and given the uncertain fiscal outlook, the onus would again be on monetary policy to do something about the short-term economic outlook. There is strong evidence that the long-term unemployed in the US are unable to find a job easily. The long-term unemployed constitute almost half of the total unemployed in the US. The situation in the US makes it a question of WHEN and not IF the US Federal Reserve would engage in another round of quantitative easing.
The UK is unlikely to be far behind with its economic growth faltering and with hawks in the Bank of England leaving the monetary policy committee. The fiscal retrenchment bravely adopted by the Conservatives-led coalition is not going well, if press reports are to be believed. Hence, the UK would also enhance its asset purchase programme as BoJ has done today.
That leaves us with Europe. So far, the European Central Bank has been the odd one out with even rate hikes, as recently as in July. But with the fiscal crisis spreading to the large economies of Italy and Spain (how long before France comes under the microscope?), the European Central Bank would have to join the race to weaken the currency.
Globally, this would be inflationary with significant risks for Asia. Unfortunately, it would come at a time when the cyclical growth momentum is already waning in Asia. All is not well in China with strikes by taxi drivers, riots in Xinjiang and public anger against the high-speed rail accident. There are breaking reports that a wave of global cyber attacks is traceable to China. Further, despite brave protestations, the Chinese economy has not been the same after the global financial crisis struck.
The mess in India is well documented. Finally, the political paralysis induced by corruption scandals has cut into economic growth forecasts. There might be more to come. The Indian stock market is a rank underperformer this year in Asia. But downside risk still persists. India’s National Stock Exchange Nifty Index is down more than 12% in US dollar terms, whereas Brazil’s Bovespa Index is down more than 14% in US dollar terms. The sheen is coming off the BRIC (Brazil, Russia, India and China) nations with the possible exception of Russia. The one saving grace for India is that interest rates are high, at least in nominal terms and it might have room to lower them next year. It might well be needed in 2012.
As of now, there is not much light at the end of the tunnel. Whatever light there is might be that of the approaching train.
V. Anantha Nageswaran is an independent macroeconomic and investment strategy consultant, based in Singapore. Your comments are welcome at firstname.lastname@example.org