Currency Intervention as Part of the Global Recovery

Last week, Brazil announced the implementation of a 2% tax on capital inflows for fixed income and equities. Apparently, this decision was intended to prevent a bubble in the Bovespa and stop the Brazilian real for appreciating any further.

However, although there is more and more discussion about the damaging effect of high/low exchange rates, it is unlikely that any significant coordinated action will take place in the near future.

Indeed, some countries are recovering faster than others from the global recession. On the one hand, in places like Japan, European Union, Brazil and Switzerland, a high exchange rate is damaging exports; on the other hand, the ongoing weakness in the dollar is making harder for the US government to keep borrowing money from abroad to stimulate the economy.

However, besides Brazil, only Switzerland has attempted to influence the exchange rate without any good results. In fact, we haven’t see any significant improvement in the country's exports or its consumer price index. Moreover, since March, when the intervention took place, the Swiss Franc appreciated 15% against the US dollar and 2% against the Euro. So, “the tax action” in Brazil is unlikely to bring any effect on the Real as the main factor behind currency appreciation is not demand for Brazilian stocks but the state of Brazilian economy, which emerged from slowdown much faster than other countries.

Surprisingly, Japan, which was badly hit by dwindling global demand and the high value of the Yen, hasn't attempted any devaluation. The problem here is that Japan is the world’s the third largest economy and any change in its exchange rate policy can easily trigger a trade war with the United States or China. This is the so called domino-effect and its consequences can be disastrous for the world economy.

Looking further, the coordinated exchange rate action is quite unlikely because it requires a change in the monetary policy. For example, in the campaign to support the Euro in 2000, interest rates in the Euro Area fell more slowly than elsewhere, causing interest-rate differences to move in favor of the Euro and creating demand for Euro-denominated assets. This kind of action is now needed to boost the value of the US Dollar. But, because the United States is still trying to boost credit availability to fight with a severe recession, the Fed will be unable to raise interest rates in the next year.

Disclosure: No positions