Euro Weakens, US Dollar Soars, Switzerland Cuts Rates in Global Currency Wars

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Isabel Schnabel of the European Central Bank initiated it. In February, she presented a chart showing how much the euro had weakened against the US dollar. Two months later, Tiff Macklem of the Bank of Canada lamented the decline of the Canadian dollar. Swiss National Bank President Thomas Jordan has hinted that he would like to see a stronger franc.

The US dollar had soared – now up 7% for the year – as the Federal Reserve (Fed) prepared to aggressively fight inflation. And so, one by one, central bankers elsewhere, equally desperate to rein in the relentless march of inflation in their own backyards, began sending not-so-subtle signals that they would for once welcome a more strong – which helps reduce the cost of imports by increasing purchasing power abroad. It’s such a rare form of intervention that their jawbone alone has moved the markets. On June 16, two of them upped the ante: Switzerland surprised traders with the first rate hike since 2007, sending the franc soaring to its highest level in seven years. Hours later, the Bank of England announced its own rate hike and signaled bigger hikes to come.

The value of currencies has become an increasingly important part of the inflation equation. Goldman Sachs Group, Inc. economist Michael Cahill says he can’t remember a time when central banks in developed countries ever targeted stronger currencies so aggressively. The foreign exchange (forex) world calls it the “reverse currency war” – because for more than a decade countries have sought the opposite. A weaker currency meant that domestic businesses could sell goods abroad at more competitive prices, which encouraged economic growth. But with the skyrocketing cost of everything from fuel to food to household appliances, boosting purchasing power has suddenly become more important.

It is a dangerous game. If left unchecked, this international competition threatens to trigger wild swings in the value of the most dominant currencies, cripple export-dependent manufacturers, upset the finances of multinational corporations and shift the burden of inflation in the whole world.

Forex wars are notoriously a zero-sum game. There will be winners and losers. Every country “wants the same thing,” says Alan Ruskin, chief international strategist at Deutsche Bank AG, but “you can’t have that in the monetary world.”

One of the most notable large-scale government interventions in the foreign exchange markets took place in 1985. The value of the US dollar had skyrocketed during President Ronald Reagan’s first term due to rising interest rates. long-term, reaching its all-time high against the British pound.

The administration initially saw this as a tribute to the strength of the US economy, but the downsides quickly became apparent. Reagan came under pressure from American manufacturers who were finding it increasingly difficult to market their products overseas. Lee Morgan, former CEO of machinery giant Caterpillar Inc., estimated that hundreds of US companies are losing billions of dollars in international orders to Japanese rivals every year because of the stronger dollar.

In September 1985, American central bankers met their French, German, Japanese and British counterparts at the Plaza Hotel in New York. In what became known as the Plaza Accord, they proposed a plan that would see the US currency fall by 40% over the next two years until finance ministers signed the Louvre Accord. in Paris which put an end to the effort.

Since then, governments have rarely intervened so explicitly to influence the value of currencies. More subtle attempts are more common. In 2010, Brazilian Finance Minister Guido Mantega gave their name to “currency wars” when he accused countries, including Switzerland and Japan, of deliberately weakening their currencies to increase their competitiveness internationally. foreign. Tensions have widened the gap between emerging economies and their more developed counterparts.

China has inflamed critics for years by refusing to allow the yuan to strengthen as cheap exports fueled an economic boom. Donald Trump targeted the country’s exchange rate during the election campaign. As the US and China traded blows with tariffs during his presidency, China allowed the yuan to weaken below the symbolic level of 7 to the dollar – a line it did not have crossed for more than a decade – which raised the alarm. the currency could be “weaponized” and cause the US Treasury Department to label China a currency manipulator.

Today, perhaps no country is better known for its efforts to limit the value of its currency than Japan, where the falling yen has lined the pockets of companies such as Toyota Motor Corporation and Nintendo Co. Bank of Japan Governor Haruhiko Kuroda went on to signal a dovish stance – while admitting that the yen’s fall is not good for the economy. The currency has fallen more than 18% this year, and traders are increasingly betting on the day when central bankers will have no choice but to reverse their position.

In today’s currency wars, the strong US dollar arguably has the most to lose. Its gains in 2022 proved a boon for a Fed trying to battle the fastest price gains in four decades. Treasury Secretary Janet Yellen highlighted the Biden administration’s commitment to a “market-determined” exchange rate, but that hasn’t stopped politicians from celebrating the dollar’s gain.

“The Fed has to do its job – it has to stay that course” in the fight against inflation, Pennsylvania Sen. Pat Toomey, a Republican, said on Bloomberg Television in May. But the strong dollar “does a lot to help,” he said.

The United States may not enjoy this advantage for long. Swiss and British rate hikes have already weighed on the dollar, which earlier in June posted its biggest two-day drop since March 2020.

Some industries will welcome the weakening. Salesforce, Inc. says it expects the dollar’s gain to cost it $600 million in revenue this fiscal year. “The dollar might even have had a stronger quarter than us,” CEO Marc Benioff said on an earnings call in May.

Developing countries, especially exporters such as Argentina and Turkey, are among the most vulnerable, says Harvard economics professor Jeffrey Frankel. Many emerging economies have more debt denominated in dollars than they have in their own currency, he says: “It’s the worst of all worlds – to see your currency depreciate against the dollar while you have a dollar debt.”

It is unclear to what extent a stronger currency will dampen inflation. The so-called pass-through rate — the extent to which an exchange rate affects the consumer price index — has been found to be minimal, says Nathan Sheets, chief global economist at Citigroup Inc., who previously worked for the Treasury Department and the Fed. But in a time of runaway inflation, it may do more good. A 10% dollar gain would previously have reduced inflation by only about half a percentage point, Sheets says. Today, he says, that could be “a full percentage point.”

Experts warn that any government intervention carries a high risk of failure. “Targeting exchange rates can be a very capricious and fruitless exercise,” says Mark Sobel, a former senior Treasury Department official who is now the US chairman of the Official Monetary and Financial Institutions Forum, a think tank. “Predicting how currency markets may react to a given policy choice can often be a wild ride,” he says.

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