Jens Weidmann, the president of Germany’s Bundesbank, warned in Frankfurt this week that an erosion of central bank independence around the world threatens to unleash a round of competitive exchange rate devaluations, as governments seek to take to control of their central banks and guide them to generate growth rather than the historical focus on inflation.
As the FT points out, both the Bundesbank and later the ECB were founded on mandates that gave them wide powers and freedom from political interference in return for focusing solely on keeping inflation in check. Some observers argue that the ECB now faces a challenge if other central banks ditch their own inflation targets and act to lower exchange rates against the euro, making exports from the embattled eurozone economies less competitive.
Independently, Forex brokers reviewed by MetalMiner admit the euro is and has been stronger than they had expected in view of the debt crisis, the repeated worries of a breakup in the euro, and projections of slow growth for years to come.
Yet the euro has remained relatively strong compared to the dollar and pound sterling, in part due to the ECB’s focus on inflation rather than growth, resulting in higher interest rates in Europe than in the other major trading blocks.
In a world of lower growth, nations seek to improve their own position through trade restrictions, manipulating currency values, capital controls and different regulatory regimes.
Some countries have been seeking to limit capital inflows where they fear they could destabilize their economies by driving up the exchange rate and increasing inflationary pressures. Brazil, South Korea, Switzerland and Hong Kong have implemented controls on capital inflows.
Others, such as the US and UK, and now Japan, have employed quantitative easing ostensibly to boost liquidity, lower borrowing costs and increase economic activity – with debatable degrees of success.
One side effect which can’t be argued is the depression of exchange rates. Every time a central bank announces further QE, the exchange rate slips further.
Now central bankers are being taken on by politicians demanding more inflation, not less. The Bank of Japan has just agreed to raise its inflation target to 2%, and to achieve this level at the earliest possible time, it aims to do this by boosting the money supply with open-ended bond purchases. To further extend the government’s influence, the governor and key rate setters are being replaced over the next three months by government-friendly nominees.
The problem for Europe in this is that the ECB is not controlled by any government – indeed, it is to all but independent of democratic control, unlike the Bundesbank it was supposed to be modeled on. As central banks elsewhere take progressively more creative steps to boost growth, one of which is lowering their exchange rates, the ECB is understandably looking on in alarm as it is left behind with its focus solely on the rate of inflation.
We have heard of worries over currency manipulation since the onset of the financial crisis, but usually from the governments of countries like Brazil – now as central banks join the clamor of concern, maybe we should take more notice.