Renewed Talk of Currency Wars in Aftermath of Jackson Hole Meeting

In the aftermath of the Kansas City Feds annual Jackson Hole conference, there has been renewed discussion of a potential currency war. Central banks responded to the financial crisis by pumping trillions of dollars worth of liquidity into the financial system. It wasnt just the Federal Reserve that engaged in those policies of quantitative easing the Bank of England, Bank of Japan, European Central Bank and others did the same thing.

Those QE policies served to weaken currencies, but because everyone was weakening their currencies together no one country was gaining a competitive advantage. Now that QE has come to an end and the Federal Reserve has announced that it intends to reduce the size of its balance sheet, one would expect other central banks to follow suit, but that doesnt seem to be the case.

There had been some speculation that ECB President Mario Draghi would discuss monetary policy at the Jackson Hole meeting, perhaps electing to discuss the potential for tightening monetary policy, but he chose to remain silent. One factor confounding him is the dollars recent weakening against the euro. While one would expect central bank tightening to result in a stronger currency, the dollar has instead weakened against the euro in recent months. That could be tying Draghis hands, as any tightening by the ECB might further strengthen the euro and harm European exports. Draghi has a tough tightrope to walk on that score.

Of course, the Feds balance sheet tightening has yet to take place. While its expected to be announced sometime soon, until it takes effect no one really knows what effects it will have on the dollar and its relationship to other currencies. The dollar has also weakened against the yen in recent months, despite the fact that BOJ President Haruhiko Kuroda has pledged to maintain accommodative monetary policy for a long time to come. That dollar weakening could throw central banks for a loop, causing them to break the policy coordination that has occurred for the past decade and usher in a new era of currency conflict.

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