Central Banks find a new policy tool, Currency Intervention. Will it help or will it make things worse?

Friday was a day which saw surges in stock markets with the Dow Jones Industrial Average rising by some 197 points to 10860 and European equity markets were led by the German Dax index which rose 114 points or 1.84% to 6298. If one looks for an economic cause for this move then the main figure on the day was US durable goods. However if one just looks at the headline figure which in fact declined by 1.3% then we find no real help for the rally it is only if we look at some of the breakdown figures such as the one which excludes transportation that you see something more hopeful as it rose by 2%. In case you are wondering as to why ex-transportation figures are looked at it is because they exclude aircraft manufacture which is a somewhat erratic series. For those wondering what durable goods are here is the definition used by the Financial Times.

Goods that are intended to be used over a length of time (at least three years according to the official definition used for US government data). These include capital goods used by businesses as well as consumer durables, such as appliances (hard or white goods as opposed to soft goods or consumer non-durables).

Personally I feel that the durable goods figures may have helped a little in the rally but the market was indicated up 100 points before they came out so it seems that the market wanted to go up anyway, the figures role was perhaps not to be bad enough to stop the apparent surge. This morning the Japanese Nikkei 225 equity index has joined in with the rally as it has risen by 131 points to 9603. However it has in effect lost ground compared with the Dow Jones as the difference between the two indices is now 1257 or 13.1% of the Nikkei’s index level.

Commodity Price Rises Continue

The Commodity Research Bureau spot index has now risen to 484.74 up 3.93 or 0.8% from its previous close. Over the past year this index has now risen by some 27.9% and those interested in the development of the so-called “agflation” will be interested to know that the foodstuffs component rose by 1.2% on Friday which followed on from strong moves in fats and oils and livestock earlier in the week. The foodstuffs component is made up of the following according to the CRB “Hogs, steers, lard, butter, soybean oil, cocoa, corn, Kansas City wheat, Minneapolis wheat, and sugar (40.9%)”. For those unfamiliar with the terms hogs are pigs and steers are cattle.

Currency Intervention: a dash for the bottom.

Ben Bernanke and the US dollar

I have been reading a speech by Federal Reserve Chairman Ben Bernanke and in case you are wondering why a speech from 2002 attracted my attention then let me give you the title. “Deflation: Making Sure “It” Doesn’t Happen Here”, it might almost be from 2010 might it not? If nothing else it is a reminder that there were similar fears to now post the events of 9/11. However here is Bernanke’s view on dollar devaluation in an economic slowdown.

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it’s worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt’s 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt’s devaluation.

The section in bold is my emphasis and not his. I point it out because on his watch and in a period of zero interest rates we are seeing a fall in the US dollar which the more I see of it the less like a coincidence it looks. The US (trade-weighted) dollar index has fallen by more than ten percent since early June and now stands at 79.4. As the rhetoric level of US politicians increases on the subject including a move to try to pass a law to make China comply which strikes me as not a little bizarre I more and more incline to the view that this is an instrument of policy.

There is a further section on Japan which concludes that Japan could have got itself out of what is now called the lost decade but for the following factor.

As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve.

I find projecting that view going forwards somewhat troubling as it potentially describes quite a likely US outlook post the November elections.

The Price of Gold and Central Bank fallibility

This speech also brought to my mind one of my themes that of the rising influence of central banks in the worlds markets which to use a euphemism has put them in positions above their “pay grade” in my view. Here is what on the face of it is an innocent little sentence.

Today an ounce of gold sells for $300, more or less.

If one remembers this is 2002 then we were at a time when it was the fashion amongst central banks to sell gold. In my own country our Chancellor Gordon Brown sold some 400 tonnes of it and many other central banks joined this game. Sales per year by central banks were of the order of up to 500 tonnes per year until this year. As the price of gold touched some US $1300 per ounce on Friday this strategy looks rather incompetent. However as they usually bought other government bonds with them they are likely to have some offsetting from the profits realised by the rally in these bonds, although care is needed here as for example any money that went into Greek bonds would not be at a profit and would now be looking somewhat risky. My point on the skill of central bankers is that in most cases they have now stopped selling gold. So they are willing to sell at lows but not highs in a strategy which if they were fully aware of it would have taxpayers knocking on their door asking for an explanation and probably sanctions.


You might conclude from Chairman Bernanke’s speech that the Roosevelt period of the New Deal and currency devaluation was a clear success of policy. I believe that more care is needed here as after these policies which were a type of beggar-thy-neighbour plan, world trade was lower in 1938 than it was in 1928. The real force which got the world out of the 1930s was rearmament for the second world war which is a disturbing thought.

Japan and her problems

One country which has overtly set out to resist the fall in the US dollar has been Japan as she has actively intervened to try to halt the rise in then Yen. However the Yen remains firm and is now at 84.21 versus the US dollar leaving us yet again with debate over how committed Japan will turn out to be to this policy. There are clear political risks as tensions are rising between her and China with the Chinese understandably wondering why another net exporter is allowed to weaken its currency whilst China is under pressure to strengthen its own.

In terms of economics then figures today showed that the rate of growth in Japanese exports has slowed to 15.8 % on a year on year basis compared to figures as high as 45% earlier this year. Of course most countries would love such a rate of growth. However this has led to concern in Japan and there are ever more rumours that there will be a new stimulus package to try to boost growth. This must be awkward to say the least for Prime Minister Kan as one of is main stated objectives is to reduce the deficit whereas in reality he finds himself forever discussing new stimulus plans. Things are not going well in Tokyo I fear.Just to add to this is looks as though the consumer finance company Takefuji is in the process of filing for bankruptcy or at is prefers to call it  “considering and implementing various measures right now to revitalise” its business.

Latin America

In a way of emphasising that this problem is spreading I noticed on the newswires that two Latin American countries Peru and Brazil both intervened against the US dollar on Friday.

Ireland’s continuing problems

One country that in many respects might like to devalue its currency is Ireland,although some care is required here as I understand that European law would enforce the Euro value of many assets. So a fall in the exchange rate of the new Punt would raise many debt obligations in Irish currency.

Of course in reality the Euro has been rising recently which does not help Dublin at all. However it has had a response which was to hold a conference on Friday to counter all the negativity about Ireland that has been going on. In a similar vein I notice that the chief of property lending at the Irish bad-bank NAMA said this last week.

“We’re really a property company, not a bad bank,”

Sadly no-one told the author of the article as just a few lines lower we get,

NAMA was set up to repair Irish banks’ impaired balance sheets and improve liquidity by removing the worst property loans.

If we return back to reality the ratings agency Moodys has been downgrading some of the debt of Anglo-Irish Banks debt this morning. Initially this gives me two main thoughts,one is about stable doors and horses and the other is that the market consensus view on Anglo-Irish is already very low. We are expecting a report on this subject from the Governor of the Irish central bank on this subject this week and it is unlikely to be good for Irish taxpayers although the Governor will presumably be subject to the new “good news” dictum. I do not envy him there.

Those who follow the performance of the Irish government bond market need a caveat this morning,whoever put the figures into the FT made a mistake on Friday’s close. A notional ten-year government bond yield was more like just over 6.5% than 6.88%. So bad but not that bad. Looking at shorter maturities we are seeing rising yields such that even a bond that matures in April 2014  closed at 4.98%. The significance of this is that at rates of over 5% it becomes cheaper to borrow from one of the support operations established by the euro zone. I also notice that more and more other places are coming round to my theme that in practice there are likely to be problems with the operation of the Exchange Fiscal Stability Fund or EFSF.

In the short-term there may be some work for the European Central Bank and its Securities Markets Programme. It has recently been buying debt again and one does not have to think too hard to see whose. It could increase its purchases but with some members of the ruling council against the whole concept this may not be easy. I have written before about the low quality of the assets on the ECB’s books and that may be beginning to trouble those on the Council.


We are seeing central banks intervene in more and more areas. The current favourite is fast becoming currency intervention. Whilst this is a conventional policy tool for a central bank it comes at a very dangerous phase in the recovery to my mind and has many political risks. After all everybody cannot devalue and there is the danger of beggar-my-neighbour policies. Those who have more faith than me in the credibility and skill of central banks would do well to review the skills they have displayed in their policy on gold.


8 thoughts on “Central Banks find a new policy tool, Currency Intervention. Will it help or will it make things worse?

  1. What kind of problems do you foresee the EFSF creating? Two arguments I’ve heard are that 1) it could crowd out weaker sovereign issuers (i.e. once somebody uses it, it becomes more likely others will need to), and 2) the more users there are, the smaller the pool of guarantors becomes. So you could imagine it setting off a sort of chain reaction of failing PIGS once it is accessed. If we get to a point where Spain is in need of a bailout, the whole Euro project will be in jeopardy. I fail to see how this could be the first step in creating ‘Eurobonds’ as some of the EFSF’s architects seem to have envisaged. Also, who do you think would buy EFSF bonds? It could be that this scheme is intended as a European bank bailout, by taking compromised bonds off their books (including Greek debt, Irish debt covering NAMA etc.).

    • Hi Graeme
      I think there are a wealth of issues with the EFSF. Let us start right at the beginning and the phone rings and at this time we would imagine an Irish or Portuguese voice would be heard. With all the shock and awe firepower there should be plenty of money but oops at that time the EFSF hasn’t got any. It would have to talk to the EU for the 60 billion Euro fund and to the IMF for some money and also to the ECB as its Securities Markets Programme would be needed to support whatever bond market needed funding.Here is my understanding of what would happen in practice.

      “A eurozone member state seeking financial assistance must initially agree a
      Memorandum of Understanding (MoU) with the European Commission, in
      liaison with the IMF and the ECB. This MoU will set out the budgetary and
      economic policy conditions which the eurozone member state must comply
      with in order to receive financial assistance.
      The detailed terms and conditions would then be set out in a Loan Facility
      Agreement which is subject to the agreement of all the guarantors (i.e. those
      countries in the EFSF). The company running the EFSF will be responsible
      for raising the funds it requires to advance the loans to the borrower.”

      Hardly likely to be Mr. Speedy is it? I know that some economic commentators have recently been praising the EU for speed of response which must make Greek readers spill their coffee at least and leads me to look up the word speed in a dictionary. Anyway the mechanics are an obvious problem and leads not only to the question how long but if as it does say “subject to the agreement of all the guarantors.”What if someone says no?

      Now even if everyone agrees there is another flaw in that the EFSF has to issue bonds. By definition it is likely to be doing so at an awkward time, what if it struggles to issue them or only manages a part-issue? It is not clear to me that this was thought through. We are about to enter a phase where there will be an enormous amount of bond issuance and it is possible that this will lead to shortages of demand or rises in interest rates. After all the value of a triple A rating is not what it was. So it may well be ok for a small country like Ireland but if others join or a larger economy hits trouble….

      Once this is in operation it is in effect piggy-backing off Germany’s credit rating. With bund prices as they are this may not be a problem but if yields rise the German taxpayer may object. Indeed it is possible that Germany is becoming less and less happy about what is being done in its name.

      I completely agree with point 2 of yours as each time it gets used the EFSF gets weaker and not stronger… Point one might be true but might not.

      By contrast the US NCUA bailed out 3 credit unions in the US with no trouble at all on Friday with 50 billion dollars at risk maybe. Why? Because everybody know the US taxpayer stands behing it and the US is a sovereign nation. Here we hit another fundamental flaw and we are back to the old Euro problem it does not have explicit taxpayer support and in a crisis this matters.

      • Thanks – very interesting, especially regarding conditions a member must comply with to receive assistance. No wonder there are still huge spreads between Bunds and other Eurozone bonds…

        • Also just to add the size is not as expected because of the 120% over-collateralisation. I wrote about this on the 25th June and it ends up at around 366 billion Euros. As ever with the Euro zone things are often not as badged.

  2. Its a compare and contrast moment. Spencer Dale struggles to explain to Cardiif Business School how our credit-starved economy protects its cash flows by quickly passing on exchange-rate price effects of depreciation,energy price increases and indirect taxation leading to persistently above-target inflation. Stateside, we have your suggested devaluation “tool” to boost inflation. So, should we now appreciate our currency to combat import-induced inflation? What, then, about combating energy rises and taxation. Seemingly, as demand increases and cash flows and credit improves and spare capacity reduces, margins will narrow due to competition and inflation will wane. A lot of ‘ifs and buts’ and an assumption of perfect markets operating at all times.

    • Hi Shire
      We are in effect the small open economy of economics text books. We have been buttressed in the past by this feature and we may well do so going forwards as with all the international pressure brewing I expect conditions to be choppy and volatile. Recently we have been relatively lucky in that we have drifted lower against the Euro and rallied a bit against the US dollar. So anti-inflationary on the one hand and hopefully helpful to growth on the other although our 2007/08 depreciation has disappointed in growth terms as far as one can tell.

      As for Spencer well he and the MPC keep coming up with new views and changing existing ones. I have remarked before on QE that there is no great need to put too much time into the MPCs explanations of it as like as a bus a new one will soon be along….. Somewhere in there is why they are struggling to get the message across combined with a failure to hit their inflation target.

  3. You talk about people starting to come round to the idea of saving, and the central bank undermining that idea just as it starts to bear some fruit. However, surely the problem is that people just aren’t acting rationally. When saving rates were good people borrowed and didn’t save. Now the central bank has cut rates to encourage spending and all of a sudden people are looking to save. There are many virtues to saving. But right now we as an economy need people to spend. So surely the bank is right to encourage spending and discourage saving. If people do this then demand will rise, upward price pressure will return and the bank will respond by raising interest rates and rewarding savers once again.

    The banks problem is that people seem to be perverse (or at least very sluggish) in their spending versus saving decision-making. If you have money right now, it is a great time to buy underpriced assets. It’s a great time to invest. It’s a great time to spend. But sadly, only if enough people spend, otherwise the potentially high rates of return will never materialise. Savers would do well to heed his advice and buy up those oversold assets – houses, banks, start-ups. When interest rates rise again they can take profits and find a new nest-egg account at a proper rate of return. I agree the banks and governments have a very large responsibility for the debt, and savers are being unfairly punished. But the punishment is the right course of action to prevent everyone from losing; simply put savers are helping no-one by being thrifty at a time when we could really use some risk-taking to jump start our economy.

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