Alexei Ulyukayev the first deputy chairman of Bank Rossii, the Russian Central Bank, stated the obvious last month, when he warned of a potential escalation of the global ‘currency war’. Highlighting Japan’s recent efforts to weaken the yen – which reached its lowest level against the US dollar (USD) in two years – Ulyukayev warned that other countries would soon follow suit, in a series of reciprocal devaluations that would ultimately prove damaging to the fragile global economic recovery. Bank Rossii, which manages the world’s fourth largest foreign exchange (FX) reserve portfolio, did not buy any USD or euros (EUR) in December for the first time since it began recording the data in 2008, possibly indicating officials’ unease with the state of the global FX markets.
The effectiveness with which global central banks have devalued their currencies over the past decade is partially masked by the fact that they are typically benchmarked against one another; as such the brutal efficiency of currency devaluation can often be done in the shadows. However, when currencies are measured against a ‘currency’ which cannot be devalued – such as gold – the reality becomes much clearer, as indicated in the following chart:
Source: Validus Risk Management, Bloomberg
Using the last decade as a guide, it is clear that both the US and the UK have been (slightly) more aggressive currency manipulators than either the European Central Bank (ECB) or the Canadians. However, as we are obviously more concerned with the future than we are with the past, it is necessary to consider whether this trend is likely to continue into the future – not an easy question, akin to asking which burglar you would most trust to mind your house when you are away on holiday!
Who to trust?
In my view, the Europeans and the Canadians remain the most trustworthy, albeit for quite different reasons. For the ECB the incentive to devalue is less straightforward than for most central banks; simply because it is beholden to more than one sovereign. As such the benefits of money printing, for instance to subsidise excessive government spending, are felt unequally amongst the eurozone’s various members. As such, some (typically richer) members, such as Germany, are much more reluctant to support unconventional central bank strategies, such as quantitative easing (QE). Wolfgang Schaeuble, the German finance minister, warned last month that such policies reflected a “false understanding of central bank policy”, and that they were creating an “excess of liquidity” on the global financial markets. Contrast this view with the current actions of the US Federal Reserve, which continues to brazenly monetise anywhere from 70% to 100% of the current US deficit by way of the ongoing quantitative easing programme and ask: who would you most trust to preserve the value of your currency?
In Canada, a reluctance to embrace radical monetary policy (Canada, like the ECB, has not engaged in QE) and a sustainable budget deficit at about 1.4% of gross domestic product (GDP) has resulted in a Canadian dollar which looks substantially – at around 20% – overvalued by conventional purchasing power parity models. However, in the context of the global currency wars, this valuation might very well be warranted. When you compare the Bank of Canada’s conservatism to the UK, for example, where the Treasury has taken to using ‘profits’ generated by QE (earning income from borrowing rather than lending is a truly impressive feat!) to reduce the reported level of government debt, it is not difficult to see why the market places a premium on the Canadian dollar.
‘With great power comes great responsibility’ wrote Voltaire in 1832; a sentiment echoed 170 years later by Spider Man’s uncle Ben Parker. The ability to create money from thin air is a great power indeed; the future direction of global FX markets will be determined by who wields this power most responsibly.
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The statement issued by the bank also suggests that fiat currencies are superior, due to their price stability.