Tags: ECB | Federal Reserve | Japan | China

Central Bank Actions to Avert Deflation May Trigger Currency War

By    |   Friday, 21 November 2014 12:34 PM

U.S. Secretary of the Treasury Jacob Lew on October 15 warned Europe was at risk falling into a downward spiral of falling wages and prices. He said recent actions by the European Central Bank might not have been enough to ward off deflation.

Several EU monetary observers disliked his remarks for being too harsh. At the subsequent G-20 meeting in Australia, the possible consequences of the eurozone’s close to zero growth, high unemployment and threat of deflation were made clear.

One indicator of inflation estimates shows the concern: eurozone 5-year inflation swaps are now trading at below 1 percent, the lowest level since 2008, the onset of the financial crisis.

The European Central Bank faces a serious “mandate” compliance problem with its task of maintaining inflation anchored below 2 percent.

ECB President Mario Draghi, speaking on Friday in Frankfurt, confirmed the central bank will do all it can to prevent stagnation in the eurozone.

“We will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us,” he said. “If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialize, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases.”

More important, Draghi didn’t discuss plans for the central bank to buy the debt of European countries, the final step in undertaking quantitative easing. This means the bond buying probably won’t be on the table for the bank’s leadership for months.

Direct buying of government debt faces serious hurdles in complying with Germany’s constitution. The Bundesbank, Germany’s central bank, is the biggest ECB shareholder and the country has the biggest economy in the eurozone.

So far, the markets seem to like what Draghi promises. Equity markets are up, the dollar is up, gold is up and the euro is down. It’s evident, so far at least, the markets don’t seem to take into account the speech of Jens Weidmann, president of the German Bundesbank. At that gathering, he said: “It is far more important to improve the longer-term revenue prospects of non-financial corporations. And it is important to improve sustainable job perspectives. Both can only be achieved through structural reforms which bolster competitiveness and boost economies’ growth potential.”

Markets react in an impulsive way and certainly don’t wait until all the subject related news is out and digested, and therefore bad news becomes good news and once again hope is what drives the markets, at least in the short term.

One of the big lessons I’ve learned during my life is: As an investor, always try to remain as realistic as possible and certainly never build on hope.

Maybe it could be helpful someday to remember as an investor what J. M. Power said: “If you want to make your dreams come true, the first thing you have to do is wake up.”

The People’s Bank of China on Friday cut its benchmark interest rates in an effort to boost the growth rate of its economy

Effective November 22, the new one-year deposit rate will be lowered by 0.25 percentage points to 2.75 percent, while the one-year lending rate will be cut by 0.4 points to 5.6 percent. China has room to ease further, which shouldn’t be disregarded in the event of any adverse economic readings.

Directly related to this, Japanese Finance Minister Taro Aso just said the Japanese yen weakened “too quickly” in the past week. He added foreign exchange rates should be determined by the markets, which means everybody should play by the rules. Unsurprisingly, he also talked the talk when he dismissed the need to intervene, but added that rapid currency moves, whether up or down, are undesirable. Once it becomes undesirable, we'll see interventions.

The actions of those two economical mammoths, China and Japan, are laying the groundwork for currency wars in 2015.

Finally, gold is up at the same time when the dollar is up, and could be bound for an important upward move of between 15 and 25 percent, bringing it back up to the range of $1,430-$1,500 an ounce.

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U.S. Secretary of the Treasury Jacob Lew on October 15 warned Europe was at risk falling into a downward spiral of falling wages and prices. He said recent actions by the European Central Bank might not have been enough to ward off deflation.
ECB, Federal Reserve, Japan, China
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2014-34-21
Friday, 21 November 2014 12:34 PM
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