Currency Wars Threaten Global Stability

At the outset of the 2008 Global Credit Crisis, developed nations and emerging markets around the world joined together and slashed short-term interest rate targets to historically low levels.  When Lehman Brothers fell in the early fall of 2008, banks around the world entered into protectionist mode.  No one knew who the next Lehman would be, and, therefore, banks simply stopped lending to one another.

When banks stop lending to consumers, the economy can come to a grinding halt, but when banks stop lending to one another the entire global economy could completely fall apart.  This was the reality and gravity of the situation during the fall of 2008.  Thus, Central Banks around the world slashed short-term interest rates in an attempt to stimulate credit markets and encourage bank lending again.  The unprecedented stimulus measures actually worked to some degree, and interbank lending market loosened just enough to stave off a complete crisis.

Developed World Interest Rates

Developed nations have been very slow in returning interest rates to normal levels.  In the United States, the Federal Reserve has held interest rates at 0-0.25% for nearly two years now.  In the U.K, interest rates have been held at 0.5% for the same amount of time, and in the EuroZone rates have been held at 1.0%.  The economic recovery in each of these regions is still quite fragile; thus, Central Banks believe that economic conditions still warrant these accommodative measures.

Consequently, these extremely low interest rates have created very little incentive for investors to hold debt denominated in these currencies in fx trading.

Let’s take the U.S. dollar for example.  If an investor is earning less than 1% interest on his money when it is in U.S. dollar, there is very little incentive for him to keep that money in U.S. dollars.  Why wouldn’t the forex trader simply take those U.S. dollars that are earning no interest and go place the capital in higher yielding currencies?. For those trading online, on sites like fxcm.com,  The answer is that he will and he is.  In fact, there is currently a massive inflow of capital into emerging market currencies because emerging market currencies are offering interest rates that are substantially higher than interest rates in the developed world.

Emerging Markets

Emerging markets have weathered the crisis of the last two years quite well.  Robust economies such as China, India, and Brazil have not been adversely affected by the recession due to several reasons.  First of all, none of them were heavily exposed to the Sub-Prime Mortgage Industry that caused a meltdown in the developed world.  Second of all, continued demand for their cheap exports helped economic growth remain consistent.  Therefore, emerging markets have kept interest rates substantially higher than the developed world over the last two years.

During the first year of the global recession, this was not much of a problem because investors were scared into the safety of the U.S. dollar; however, over the last year, investors have been buying up emerging market bonds with fury due to the devalued developed world currencies.  This huge capital inflow into emerging markets has caused emerging market currencies to appreciate rapidly, and expensive currencies are beginning to weigh on emerging market exports.  This has caused some emerging markets to intentionally intervene in the currency markets in an attempt to fight off a stronger currency, and Brazil has gone so far as to double a tax on foreign investors who purchase Brazilian bonds.

This conflict between emerging markets and the developed world will most likely not cease anytime soon, especially as the United States and U.K. are considering further stimulus measures, which will only make their currencies even more unattractive to investors.  An online forex brokerage allows traders to observe price movement of these currencies using charts and services on their websites.

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