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16 Jun, 2013

Don’t Say We Didn’t Warn You: America Declares War on World Currencies

Thanong Khanthong, The Nation

June 14, 2013 – It can now be fully confirmed that we are in the middle of a currency war on a global scale. On April 19, the Thai baht was trading at Bt28.55 against the US dollar. At that point, Dr Prasarn Trairatvorakul, the Bank of Thailand governor, almost lost his job. He’d failed to stem the baht’s rise. And he had also defended the central bank’s interest rate policy as appropriate for the potential growth of the Thai economy.

Prasarn is also reluctant to intervene in the foreign exchange market to weaken the baht. Doing so would create further losses on the central bank’s balance sheet when the weak dollar is converted to baht term. Yet the rapid rise of the baht, which breached the Bt28 level, is seen as unacceptable by the government and powerful exporters. The Bank of Thailand has become a punching bag.

But over the past week the central bank has been buying up the baht to prevent its rapid decline.

A sudden shift in sentiment derives from the possibility that the US Federal Reserve might cut back its quantitative easing (QE). Ben Bernanke, the chairman of the US Federal Reserve, has hinted that the Fed might pull back some of its QE, now going on at the rate of US$85 billion a month, if there are further signs of the US recovery. Standard and Poor’s, the rating agency, has also upgraded the US credit outlook from negative to positive. These signs are good enough to send the Japanese stock market and other emerging markets tumbling.

The Fed launched the currency war through its QE, which started after the collapse of Wall Street and the US stock market in 2008. By printing dollars on a massive scale and holding the interest rate to almost 0 per cent, the Fed has pursued a double-edged policy. First, the cheap dollar helps push up financial assets and prevents the banks from failing. Second, it creates bubbles in other markets and pushes up the value of other currencies and makes their exports less competitive. This is a classic currency war.

The US has given Japan a pat on the back. Japan, which has been in an economic slump for more than 20 years, has been persuaded to adopt QE. It had tried QE eight times in the past, to no avail. “Abenomics” calls for QE 9, which is designed to prop up inflation from 1 per cent to 2 per cent and double the balance sheet of the Bank of Japan to $2.7 trillion. This has helped push up the stock market by more than 70 per cent to the 15,942 level. The yen, which stood at 77 to the dollar in September last year, was also been dragged down to 103-104 recently to boost exports.

But a hint that the Fed might take away some of the punch bowls has spoiled it all. The baht has swung from Bt28.55 against the dollar in April to Bt31 on Wednesday and Bt30.95 yesterday. The yen appreciated from 87 against the dollar last year to peak at 104 before rising to 94 now. The Nikkei index has fallen almost like a stone from 15,942 to 12,582.

The events in Thailand and Japan show that we do not have control over our interest rate, foreign exchange or capital market. As a peripheral country, Thailand’s financial markets are subject to the policy of the Fed, which stands high at the centre of global finance.

This brings us to the recent debate on the interest-rate policy between the Finance Ministry and the Bank of Thailand. Deputy Prime Minister and Finance Minister Kittiratt Na Ranong, in particular, had been applying pressure for the central bank to cut the interest rate by at least one full percentage point to stem capital inflows. He believes that the wide gap in the interest rate differential between the baht (2.75 per cent) and the dollar (0.25 per cent) was the main reason for the capital inflows. Foreign money, which largely went into the Thai bond market, pushed up the baht’s value. It also went into the stock market to drive up the SET index to 1,650.

Representatives of the Finance Ministry, the National Economic and Social Development Board and the Federation of Thai Industries came out in chorus to urge a drastic cut in the central bank’s rate to stimulate the economy and also to discourage capital inflows.

The central bank has budged by agreeing to cut the interest rate by 25 basis points to 2.50 percent. It has also introduced four capital control measures in case of further rapid rises in the baht.

But the sudden outflow of capital, which has sent the Thai stock marketing tumbling and the baht on a sliding path, shows that the interest rate has little – or virtually no influence – over capital inflow. When the financial centre – the Fed in this case – coughs, all of the world’s financial markets recoil for fear of catching a cold.

We are in the middle of the currency war. But few have a clue as to what actually is happening. By playing the game of the Fed, we’ll all lose our shirts soon.

Contact the writer: thanong@nationgroup.com