What Currency War?

Most investors anticipated that US monetary easing in 2010 and 2011, or quantitative easing, would lower interest rates and the value of government bonds, depreciating the US dollar. A weaker dollar might help to lower the cost of US exports, and give a boost to domestic consumption. At the same time, however, a weaker dollar could mean that imported goods and services from foreign countries become more costly for American consumers. Analysts expected that current US investors might relocate their capital to high growth countries to take advantage of higher returns on foreign currency.

Some analysts worried that such capital outflows, or spillover, from the United States could trigger a currency war if foreign countries responded by implementing more aggressive monetary policies to maintain competitive exchange rates for their currencies. Financial data from 2011 and 2012, however, do not reflect a weakening US dollar or negative spillovers following the implementation of US quantitative easing policies.

The 2012 Spillover Report, published by the International Monetary Fund (IMF), finds no significant evidence of dollar depreciation driven by US monetary policy. The IMF evaluated the responses of long-term government bonds, stock market indices, and emerging country exchange rates to announcements by the Federal Open Market Committee (FOMC), a body within the Federal Reserve System. They find that the US dollar depreciated, or lost value, against most currencies only on the days of the FOMC announcements (in August 2011 and January 2012). The impact decreased or disappeared as the US dollar returned to stronger positions over the following days. Interestingly, the US dollar immediately appreciated, or gained value, against emerging countries’ currencies on the day the FOMC announced a monetary policy decreasing the yield on long-term bond.

In the absence of significant capital outflow from the US to foreign countries, the US dollar did not depreciate as analysts expected. Recent data from the US Treasury Department reflects that the capital outflow was not abnormally large from 2011 to 2012. In the years preceding the global financial crisis, investors preferred to purchase foreign bonds in Euros while the US government bond yield was low. But over the past few years, investors lost their appetite for riskier investments amid concerns over the sovereign-debt crisis in Europe. Instead of buying foreign assets, investors began to purchase US Treasury bonds. Meanwhile, portfolio flows to the US actually increased during the periods of quantitative easing announcements. Contrary to expectations, the US experienced capital inflows rather than outflows, so the dollar remained strong against the Euro and most emerging countries’ currencies in 2011 and early 2012.

In short, it is premature to interpret US monetary policy as a tool to depreciate the dollar or hurt other countries’ competitiveness for exports. Capital flows, which are driven by investors’ risk appetite and confidence, might be more significant indicators for recent and current financial conditions. Instead of creating negative effects, monetary easing policy might provide support to the global economy by stabilizing the market during periods of financial crisis.

Feature Photo: cc/jDevaun

chanc@uchicago.edu'
Victor Chan
Victor Chan is a staff writer for The Review and is an MPP student at the Harris School of Public Policy. He is interested in international affairs, trade policy, and public finance.

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