Competitive Devaluation Of Currencies: What QE3 Means For Forex

Includes: FXE, GLD, OIL, UDN, UUP
by: Elite E Services

The Fed's recent announcement of QE3 has undoubted effects on financial markets; but what does it mean for Forex?

The initial reaction would be that it's bad for the US Dollar (NYSEARCA:UUP) (NYSEARCA:UDN) which was reflected in Friday's move of EURUSD (NYSEARCA:FXE) to above 1.31 against the US Dollar. But just last week, traders were expecting a collapse of the EURUSD as the European financial crisis deepens.

Competitive Devaluation

The goal of many central banks, publicly or not, is to devalue their currency to boost exports. In a global economy there is no better customer than every other country. External consumption means by producing more than you can consume internally it is possible for a country to aquire more wealth than it otherwise could. At least that is the idea behind the drive for promoting exports. The model pioneered by the post WW2 United States and followed by Japan had implications for the currency markets; the weaker your currency was the cheaper your products would be to purchase from the perspective of foreigners. But there is a built in paradox in this model; every country wants to weaken their currency and has the means to do so (printing money, QE3).


The main players are currently the Fed, ECB, and the SNB. However we must not forget the BOJ and BOE. The BOJ has the most pronounced official policy of devaluation, because of Japan's export strategy. But other players should not be discounted; when the SNB decided to peg the CHF to the EUR last year, the only way a central bank can do this is by printing money (because a central bank can create unlimited amounts of it's own currency only). The term "Currency War" needs to be used lightly, as central bankers usually work in concert, and are not really trying to destroy the other party. They want a steady decline, not a collapse. Central bankers have a few things in common globally; they all want stability, they all loathe volatility, and they all want to stay in power. That means they truely want to avoid a market collapse or systemic economic meltdown.

Expanding Universe

As each central bank creates more money supply, not only is the money supply of each currency expanding, but also the system as a whole. While there are limited supplies of commodities such as Gold (NYSEARCA:GLD) and there is finite land on planet earth, there is literally an unlimited amount of fiat money that can be created electronically by the world's central banks. Stiglitz has referred to this as a game of hot potato; while Jamie Dimon called it musical chairs. The model has a few axioms:

  • Ever expanding money supply
  • Bankruptcies must exist, not every business can succeed
  • New debt needs to be created to pay off old debt
  • Inflation

Forex markets

The debt-based money system was designed before the floating Forex markets, so it's interesting to see markets react to an event like QE3.

Opportunities for EURUSD shorting remain, but traders should be vigilant. Other traders have noted a possible short term high of 1.35 which may be a shorting peak.

Don't let the recent QE3 announcement fool you; effectively nothing changed fundamentally regarding the US Dollar in the last week, and the crisis in Europe remains.

How to go short the entire Forex market

Any long positions in Gold Oil (NYSEARCA:OIL) and similar hard commodities of limited quantity is essentially a short on paper money. Marc Faber says that stocks may have the same characteristics. His point is in line with the understanding that the current policy of global central bankers will ultimately inflate assets and deteriorate the value of paper money.

Forex Risk Disclosure - Click here to read

The risk of loss in trading foreign exchange markets (FOREX), also known as cash foreign currencies, or the FOREX markets, can be substantial.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.