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Analysis
Adverse effects from European action

Adverse effects from European action

ECB easing could widen payments imbalances 

by Desmond Lachman in Washington

Wed 2 Dec 2015

On 3 December the European Central Bank is expected to expand its already highly aggressive quantitative easing programme – an attempt to kick-start Europe’s anaemic recovery and stave off deflation. The ECB will present its action as an appropriate monetary policy response to the euro area's low inflation rate. But the main channel through which its actions will work will be a further significant depreciation of the euro.

This might be good for Europe, but it will impose a substantial burden on the rest of the global economy. Crucially, the ECB’s probable action will exacerbate international payments imbalances, which could be the prelude to disorderly exchange rate movements.

It would be far better if attempts to revitalise the euro area focused on more expansive fiscal policies by those euro members, especially Germany, that have the policy room to do so. However, if the past is any guide, I won’t be holding my breath waiting for this to happen.

Since Mario Draghi, the ECB president, started to indicate that the ECB would engage in quantitative easing in autumn 2014, the euro has depreciated more than 20% against the dollar. He is now intimating that the ECB will step up its €60bn a month bond-buying programme and extend it beyond September 2016. This will almost certainly depress the euro further, especially since it will coincide with the likely start of Federal Reserve rate-hiking.

Already in 2015, the euro area is expected to run a record current account surplus of around 3.5% of GDP, while Germany will generate a record surplus of around 8.5%. Any further currency fall is bound to increase these surpluses further, especially as the full effect of the large euro depreciation over the past year has yet to work its way through.

Equally disturbing is the impact of further euro depreciation on hard-pressed emerging market economies, which to date have been the main engine of global economic growth. Generally, a weakening of the euro against the dollar is associated with lower international commodity prices. And this causes emerging market currencies to depreciate against the dollar. This is the last thing the emerging markets need, considering how heavily their corporate sectors have borrowed in dollars over the past few years of high liquidity.

According to the Bank for International Settlements, since 2008 emerging market corporate borrowing in dollars has increased by over $3tn – a significant risk to the global economy.

A further significant euro decline could threaten China’s attempts at economic revitalisation. For political reasons, especially in a US election year, Chinese policy-makers cannot allow their currency to depreciate much against the dollar. As a result, any further euro depreciation against the dollar would undermine China’s international competitive position. This is not what China needs as it struggles to rebalance its economy.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

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