Recently in many newspaper/ channels we would have come across the term Currency War. What (exactly) is a Currency War? It is a writers term (Currency war), for economist it is well known as competitive devaluation. It is a condition in international market's where countries compete against each other in order to achieve a relatively low exchange rate for their home currency, which will help their domestic industry to perish.
Normally at a certain period or given time, any given currency exists in a global markets is determined by supply (how much of a currency exists) and demand (how much investors want to buy goods and assets denominated in that currency). A country can make its goods and services more "cheaper" (some may say more competitive, because its cheaper) in the global market by devaluing its currency.
The devaluation of a currency can be made in number of ways, say, from Quantitative Easing (QE) (printing more money - by doing so there will be greater the supply of its own currency, which, would result in the less value it tends to be) to Buying of another Country's Debt (more the demand for another country's currency, the more valuable it tends to be).
QE is a practice, when a central bank tries to mitigate a potential or actual recession by creating money and injecting it into the domestic economy (so that they can avoid inflation once the economy improves).
QE to devalue a country's currency indirectly in two ways. First, it will encourage the speculators to bet that the currency will decline in value. Secondly, the large increase in the domestic money supply will lower the domestic interest rates, which will become much lower than the prevailing interest rates compared to the countries which are not practicing quantitative easing.
When a country's currency falls in value, its exports usually grow, because its goods and services becomes much cheaper on the global market. Which will benefit the export of the country and boost the domestic as well as the global market and thus achieving economic stability.
(For More info: click here and for History of Currency War)
(Refernces: Wikipedia and Investopedia)
Wednesday, October 27, 2010
Monday, October 11, 2010
Quantitative Easing and Developed Countries
I have read 2 interesting articles today (11th October 2010) in Economist regarding the Quantitative Easing, they are - 1. The magic bullet - How the bulls believe quantitative easing will boost asset prices (Oct 7th 2010) and 2. The Japanese economy - Easy does it - Symbolic moves by the Bank of Japan (Oct 7th 2010)
Before going further on these 2 articles let me give definition for quantitative easing. What is quantitative easing? Usually, central banks try to raise the amount of lending and activity in the economy indirectly, by cutting interest rates. Lower interest rates encourage people to spend, not save. But when interest rates cannot be lowered no longer then central bank's only option is to pump money into the economy directly. This is called Quantitative easing (QE).
The way the central bank does this through buying assets - usually financial assets, say government and corporate bonds. The institutions which sells the assets (either commercial banks or other financial businesses such as insurance companies) will have "new" money in their accounts, which will then boosts the money supply in the economy. Sometimes, the Quantitative Easing literally means printing money, but, nowadays the Bank don't have to literally print the money, because, it is all done electronically. However, few economists would still argue that QE is the same principle as printing money as it is a deliberate expansion of the central bank's in the monetary base.
Now coming back to those 2 articles, the First article says that the quantitative easing will boost asset prices. It states that "............ quantitative easing (QE), or creating more money to purchase assets. This is largely presented as a tactic to stimulate the domestic economy by lowering the cost of finance and putting more money into the banking system."
The article provides further information that "Over the past two years much of the developed world has attempted some form of QE. (The European Central Bank has done less than its rivals, which may help explain the euro’s relative strength.) Some see this as competitive QE, a game of “I can print more money than you can”. Many investors believe the Federal Reserve will be forced into another round of QE, perhaps as soon as November." It stresses that ".... QE is a kind of magic bullet, helping all asset prices to rise." It concludes that "Although asset prices may be buoyant at the moment, there are other risks ahead. Competitive devaluation is an inherently unstable system. Someone must lose their share of world trade. And a policy of boosting exports can all too easily turn into a policy of blocking imports."
The Second article talks about Quantitative easing and Japan. It provides the information about how japan is currently facing problem with their monetary policy and how they are trying to adopt quantitative easing in order to get out from the Economic Crunch. The article states that "The effect would be to restart the policy of quantitative easing that Japan used to claw out of its banking crisis between 2001 and 2006. The initial amount under consideration is about ¥5 trillion ($60 billion), ¥3.5 trillion of which is for public-sector debt. That is on top of a sum of ¥30 trillion already budgeted for BoJ loans to banks."
After I have read these 2 articles few thoughts arises in my mind, 1. Is QE is really a solution for the Economic Crisis and failure of Monetary Policy? 2. Whether QE will really boosts the asset's price? 3. If QE is used by an economy, then whether it's impact in the Exchange rate will be higher or lower? I am still looking for the answers for these questions.
Before going further on these 2 articles let me give definition for quantitative easing. What is quantitative easing? Usually, central banks try to raise the amount of lending and activity in the economy indirectly, by cutting interest rates. Lower interest rates encourage people to spend, not save. But when interest rates cannot be lowered no longer then central bank's only option is to pump money into the economy directly. This is called Quantitative easing (QE).
The way the central bank does this through buying assets - usually financial assets, say government and corporate bonds. The institutions which sells the assets (either commercial banks or other financial businesses such as insurance companies) will have "new" money in their accounts, which will then boosts the money supply in the economy. Sometimes, the Quantitative Easing literally means printing money, but, nowadays the Bank don't have to literally print the money, because, it is all done electronically. However, few economists would still argue that QE is the same principle as printing money as it is a deliberate expansion of the central bank's in the monetary base.
Now coming back to those 2 articles, the First article says that the quantitative easing will boost asset prices. It states that "............ quantitative easing (QE), or creating more money to purchase assets. This is largely presented as a tactic to stimulate the domestic economy by lowering the cost of finance and putting more money into the banking system."
The article provides further information that "Over the past two years much of the developed world has attempted some form of QE. (The European Central Bank has done less than its rivals, which may help explain the euro’s relative strength.) Some see this as competitive QE, a game of “I can print more money than you can”. Many investors believe the Federal Reserve will be forced into another round of QE, perhaps as soon as November." It stresses that ".... QE is a kind of magic bullet, helping all asset prices to rise." It concludes that "Although asset prices may be buoyant at the moment, there are other risks ahead. Competitive devaluation is an inherently unstable system. Someone must lose their share of world trade. And a policy of boosting exports can all too easily turn into a policy of blocking imports."
The Second article talks about Quantitative easing and Japan. It provides the information about how japan is currently facing problem with their monetary policy and how they are trying to adopt quantitative easing in order to get out from the Economic Crunch. The article states that "The effect would be to restart the policy of quantitative easing that Japan used to claw out of its banking crisis between 2001 and 2006. The initial amount under consideration is about ¥5 trillion ($60 billion), ¥3.5 trillion of which is for public-sector debt. That is on top of a sum of ¥30 trillion already budgeted for BoJ loans to banks."
After I have read these 2 articles few thoughts arises in my mind, 1. Is QE is really a solution for the Economic Crisis and failure of Monetary Policy? 2. Whether QE will really boosts the asset's price? 3. If QE is used by an economy, then whether it's impact in the Exchange rate will be higher or lower? I am still looking for the answers for these questions.
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