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Currency wars require tactical approach

THIS YEAR represents the fifth of the financial crisis. With the government, at the time of writing, unwilling to retarget its fiscal policy away from debt repayment towards a plan for growth, the onus remains on the Bank of England (BoE) to engineer a recovery. Like many other central banks around the world, since the crisis began the BoE has used loose monetary policy, via the control of interest rates and the use of quantitative easing (or the threat of it in any case), in an attempt to engineer growth.

While the government is able to target fiscal policy (i.e. taxes and spending) the BoE, like other central banks, can use monetary policy (the control of money and interest rates) to turn and tune the levers of the UK’s economic machine. Rates have been held at 0.5% for over four years now while via the BoE’s quantitative easing programme we have seen a £375bn increase in the money supply. It all adds up to one thing, an attempt to get the UK economy growing by devaluing our currency, the humble pound.

In theory by making sterling cheaper our exports look more attractive to the outside world and, all things being equal, this should see export sales increase and UK output improve. All very nice in principle, but the main problem is that most of the rest of the developed world’s central banks have been following precisely the same path – leading to what’s become known in the press as the ‘currency wars’.

These central banks would disagree that they are deliberately devaluing their currencies, but instead that by increasing the flow of money in the economy, they are trying to help kick-start growth. However, by using their powers there is no doubt that a central bank can wield extraordinary power over the value of a nation’s unit of money. For example, following a long period of Swiss franc (CHF) strength against the euro (EUR), in particular, the Swiss National Bank (SNB) imposed a de facto floor in the value of EUR/CHF so as to make sure that the CHF did not get any stronger. They did this by buying up colossal amounts of euros and holding them on the SNB’s balance sheet.

However, the most poisonous thing for a currency is negative interest rates. Late last year we saw major Swiss banks like UBS and Credit Suisse impose negative interest rates on Swiss Franc accounts. Closer to home deputy governor of the Bank of England, Paul Tucker, spoke of a Bank of England conversation where they had considered negative interest rates here in the UK. Tucker’s comments (which alone were able to prompt sterling weakness) were yet another overt example of an attempt to deliberately devalue currency, disguised as policy to get consumers and business spending.

The result of this constant tinkering in the value of the various competing currencies has been consistent exchange rate volatility over the last few years, changing the value of funds on a daily basis. This has prompted some financial professionals who manage international budgets to start taking a more strategic approach to the management of foreign exchange payments – including everything from import and export costs, to international payroll, to one-off transactions.
However, what is interesting is that the majority of SMEs are still not responding to these ‘currency wars’. According to a recent survey, the vast majority of SMEs have still not confronted the problem and tackled their exposure to the resulting currency fluctuations.

Only 17% of UK SMEs currently have contracts protecting themselves against the unpredictability of the markets for longer than the next 30 days. That number falls to just 10% when you extend the period past six months. In other words, only one in ten have deemed it necessary to protect themselves from on-going exchange rate fluctuations in the most unpredictable economic climate the vast majority of us have ever experienced.

Considering all of the unpredictability in the markets this may seems strange, but it is easier to understand these figures when you look take into account the perceived lack of options available. Products like ‘Currency Options’, which allow you to protect yourself by fixing a ‘worst case’ rate, but also allow you to benefit if the rate moves in your favour, are still fairly new to most. Previously the preserve of a few ‘in-the-know’ corporates, these sophisticated hedging products are now available to the general business market, as well as private individuals.

With the ‘currency wars’ set to continue for the foreseeable future as countries seek any and every means they can to try and kick start growth, anyone who is involved in managing international payments of any kind would be well advised to start looking at currency matters more strategically in the months and years ahead.

Jeremy Cook is chief economist at the foreign exchange company, World First

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