The dollar has been falling steadily against its main trading currencies for the last 8 weeks. So, what does a weaker dollar imply and what kind of policy responses might that provoke in the EU given the euro has more to lose with a weaker dollar.
A super weak USD could risk exporting deflation to the rest of the world
since central banks around the world are now enagaged in managing the recession with a cocktail of a) quantitative easing, b) loose monetary policies, and c) low interest rates and it leaves them very little to combat a sudden appreciation of their currencies against the dollar. This could lead to a liquidity trap and result in them being unable to dig their economies out of a deflationary scenario.
Looking back into the history books, in the last 30 years the world has witnessed several instances of central bank intervention:
1985, G7 signed the Plaza accord to weaken the dollar
1987, G7 pledged to support falling dollar
1995, G7 intervened to help dollar
1998, Americaand Japan sold dollars to prop yen
2000, ECB, Fed, BOJ and UK, Canada supported the Euro.
So, does this mean we're going to see another round of central bank intervention in 2009?
Maybe. Coordinated intervention can work(as seen in the past), but needs to be consistent with changes in interest rates globally.
So why not do it straight away?
Central bankers hate to mess around with free markets, besides it's difficult to predict the precise consequences of interventions.
Eric Tan,
London
Tuesday 22 September 2009
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