Currency War Between U.S. and E.U. Increasingly Likely as Policies Diverge

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Last Updated on: 21st August 2017, 02:21 pm

With the annual Jackson Hole Central Bankers conference occurring this week, it has firmly put the spotlight back on the already diverging policies between the world's two largest central banks, the U.S. Federal Reserve and the EU's European Central Bank.

Just this past week, a noted interest rate strategist warned that investors need to brace themselves for an increasingly likely currency war between the United States and Europe which could easily result from this shifting apart in central bank monetary policy.

Naturally this could have severe consequences for your retirement portfolio. It is why you should consider IRA-Approved gold to hedge your assets. Between such bullion choices and the top five gold coins for investors, you should be able to offset the negative effects of declining currencies on your portfolio, especially since gold is priced in all major global currencies all day every day.

The Diverging of Major Central Bank Policies Warns of A Currency War Between the Dollar and Euro

Head of Macro Strategies Alberto Gallo of Alebris Investments (who is also coincidentally the portfolio manager for their Algebris Macro Credit Fund) was out warning this past week that central banks need to seriously make efforts to synchronize their strategies as the world fearfully eases out of the low interest rate and highly accommodative monetary policy environment.

If the two major global central banks do not accomplish this, then he warns that worldwide financial markets need to prepare for the otherwise looming currency war.

“We're going to an environment of lower marginal stimulus but unwinding their (ECB and Fed) balance sheets will be very hard. If you don't do it in a synchronized way, there's going to be a currency war. What we have seen over the past few weeks is an example. The euro rapidly appreciated to over $1.18 after the Fed turned more dovish, as confirmed by the latest ECB minutes. In turn, this can hurt euro zone exports, effectively redistributing inflation back to the U.S. and other countries, and forcing the ECB to step back on tapering too.”

Gallo is actually quite an expert on this subject, having written a great deal before on the idea of “QE Infinity.” In this situation, lower interest rates and apparently inexhaustible rounds of the bond buying programs were designed to foster more investment and easier, less-expensive borrowing throughout the financial markets.

Problems come in as the one currency over appreciates against the other. For example, the recently stronger euro has caused European products to be more costly to consumers outside of Europe. This includes consumers living in the United States. Only last week, the ECB's minutes off of their most recent meeting demonstrated that the various policy members are collectively worried about a potential overshooting of the euro currency.

Gallo explains why they are right to be concerned if not outright worried, with:

“The result of a currency war can be a race to the bottom, where each central bank is afraid of making the first step and exiting quantitative easing (government's bond-buying program) becomes incredibly difficult.”

The problem is even more pronounced when you consider that analysts at Citi do not anticipate the European Central Bank raising its interest rates (for the first time since the Global Financial Crisis) for another two long years.

The most the European policymakers will agree to is a communique that states they are looking into ways to ease up on their monetary stimulus programs. This might entail reducing the amount of government debt they purchase every month while not cutting the benchmark interest rates any longer in order to boost the economy's money supply further.

On the other hand, the United States Federal Reserve is doing more than just “exploring” and “talking about” unwinding their over $4 trillion balance sheet. They are actually raising interest rates and setting out a path for how and when they will allow their government debt reinvestment purchases to simply roll off.

Yet for either central bank, this is not as easy in practice as it appears on paper. This is because after nearly a decade of continuous monetary stimulus, policymakers, analysts, investors, and the worldwide economy have become accustomed to the idea of cheap and easy money alongside laughably low interest rates.

A Currency War Between The Dollar and Euro Can Actually Happen

You might be wondering how a currency war can simply erupt without state actors intending such dire consequences. The answer is that such disturbances can break out fairly easily when any nation or group of several nations attempts to obtain an advantage in trade simply by depreciating their own currencies deliberately with respect to the currencies of other economically competing states.

With regards to the dollar and the euro, analysts have foreseen one breaking out if the Fed (which has been more hawkish than the ECB) suddenly takes a hard step back into dovish territory. They might do this by delaying their promised rate hikes. It would unintentionally weaken the United States dollar. Gallo opined on this, with:

“We're worried about fiscal stimulus delivery in the U.S. If the Trump administration doesn't deliver then the Fed becomes more dovish, which means there's not going to be enough dry powder (cash reserves) to overcome the next recession.”

This is on the horizon, since markets and investors believed in U.S. President Trump's much-touted large infrastructure investments and significant tax cuts which have not materialized so far. Such optimism is no longer taken for granted by the markets with the President not delivering on any of the pledges as of yet. It has raised serious concerns on whether any of these accommodative policies will ever get off the ground or not.

Instead, markets have watched in growing despair as the Federal Reserve began to turn to a slightly less optimistic stand on the economic future of the world's largest economy. The U.S. central bank released a statement in July on inflation, saying that it was “running below two percent” as compared to their statement for June that argued it was “running somewhat below two percent.” The markets saw this as a slightly more dovish stand, causing the U.S. dollar to decline.

This mild fear gained more traction over last week as the Fed released the minutes from its prior meeting. In this, it demonstrated that the national policymakers were divided on the speed of interest rate increases going forward. It made the Federal Reserve appear all the more dovish. Yet while the Fed could conceivably still announce its next tightening move as soon as next month, the ECB will not follow suit until much later.

The biggest concern that could impact you and your retirement portfolio has to do with this upcoming great unwinding which will eventually occur everywhere. Exiting the existing quantitative easing means that the world's six largest central banks (Fed, ECB, Bank of England, Bank of Japan, Swiss National Bank, and Bank of Canada) will have to collectively wind down an enormous amount of government assets and debt. The Financial Times of London warns that these central banks collectively hold over $15 trillion in assets, of which $9 trillion are outright government bonds.

This begs the question, where are all of these buyers for the trillions in government paper going to come from next? In fact it could be the next big problem for world markets after the danger of a currency war passes. Besides this, the Bank of International Settlements has already warned higher interest rates will wreck sovereign governments. Gold is your ultimate proven safe haven asset in times of financial crisis. This is why gold makes sense in an IRA. It's time to review what is a gold IRA.