Guido Mantega, Brazil’s finance minister, caused much excitement in autumn 2010 when he said what a lot of policymakers were probably thinking and warned that the Fed’s super-easy approach to monetary policy after it announced QE2 had triggered a currency war.
Mantega is back voicing the same concerns after QE3, but this time battle lines are unlikely to be drawn.
There is an obvious link between the rise in the balance sheets of the central banks in the G4 – the Federal Reserve, European Central Bank, Bank of Japan and Bank of England – and global currency reserve growth.
As funds flow from the G4, and in particular the US, other central banks intervene to suppress the value of their currencies and protect their export sectors – reserve growth, in other words, is a symptom of currency wars.
Therefore, 2010 and 2011 saw global currency reserves rise at a record pace thanks to easing from the G4.
| G4 aggregate central bank balance sheet versus |
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| Source: Morgan Stanley, Haver Analytics, Bloomberg |
However, this time, things are different.
As Hans Redeker, head of global FX strategy at Morgan Stanley, points out, four conditions generally hold in times of global currency reserve growth.
There are normally diverging trends in domestic demand, over-investment due to mercantilist policies in reserve building countries, growth divergences that lead investors to move capital into higher-yielding environments, and central banks running excessive monetary-account surpluses via QE operations.
Redeker says three of the four conditions for reserve growth are no longer in place.
“Global domestic demand trends have converged,” he says. “EM countries’ net export growth is slowing down and investment has shifted away from boosting export capacity and towards infrastructure.
“Last, but not least, real-growth differentials have tightened, as evidenced by the easing inflows into EM funds.”
It is therefore no longer a given that the latest round of Fed easing will lead to an outflow from the USD into other currencies, as seen in previous rounds of QE.
“Funds allocated by the Fed may stay in the US, boosting local asset prices instead of international asset prices,” says Redeker.
“Consequently, currency reserves might not rise meaningfully, suggesting Mantega’s warning of a currency war could have been premature.”