The heating global financial war

Issuing billions in fiat currency has devalued the dollar resulting in cheaper US exports.

“The last time there was a series of competitive devaluations, it ended in World War II,” said Dilma Rousseff, Brazil’s president elect.

There has been growing concern about the US Federal Reserve’s latest $600 billion stimulus plan announced on Wednesday in terms of effectiveness and long-term impact. The stimulus aims to pump more money into the economy, lower interest rates and encourage consumer spending.

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion,” wrote Fed Chairman Ben Bernanke in a recent article published in The Washington Post.

This was the first time the Fed has admitted to wanting the stock markets pumped. Equally important, it also provides a succinct insight into plans to resolve the crisis through increased consumer spending. All this comes at a time when US consumer debt and defaults are at peak levels.

Quantitative easing and currency wars

The Fed has been using quantitative easing, or money supply expansion, to introduce this credit into the market. This is done through electronic means rather than actually printing money.

The central bank credits its own account with extra money and then disperses it by purchasing financial instruments such as government bonds, corporate bonds and similar money market operations.

The Fed has also long been suspected of directly pumping this money into the stock market but this has never been confirmed.

While it purports all this is designed to spur consumer spending and create a virtuous cycle, another parallel reality is unfolding. Issuing billions of dollars of fiat currency has devalued the dollar resulting in cheaper US exports and costlier imports.

This puts pressure on other countries to respond by devaluing their own currencies to remain competitive in global trade. At the forefront of this battle is China, which let its currency slip by as much as 20 per cent since 2005 but pegged it back to the dollar in 2008, putting the greenback in a tough spot.

The US, in turn, is demanding that China raise its currency by 20 per cent.

Another perverse effect of the quantitative easing is that it has essentially issued the credit to financial institutions which are using it to purchase assets in other countries.

“The money isn’t going into the American economy. The lending is actually below what it was in 2007. In a globalised economy, the money is looking for the best place to go. And where is it finding it? In the emerging markets. So, the irony is that money that was intended to rekindle the American economy is causing havoc all over the world,” explains Nobel economist Joseph Stiglitz.

The global financial crisis is far from over and it also brings into question Pakistan’s own policies on currency devaluation, stock markets and other financial operations.

The writer is heading Online Strategy and Development at Express Media.

Published in The Express Tribune, November 15^th, 2010.