The old saying "When elephants fight, the grass gets trampled" captures perfectly the dilemma of the world's non-superpowers. From Brazil to Thailand to non-eurozone Europe, the currency war raging between the leading economies is creating collateral damage. Here's Bloomberg on the war's European theater:
Draghi's bonanza of cheap cash is depressing financial returns in the euro area and driving investment flows into neighboring countries, pushing up their currencies and defeating their efforts to hit their own inflation targets. Looser monetary policy is in the cards even in countries where economic growth is strong and asset markets are overheating.
"These countries don't want to be the losers in the currency war they think the ECB is participating in," says Marchel Alexandrovich, senior European economist at Jefferies International Ltd. in London. "It's a zero-sum game. If you're trying to devalue, then there's always someone on the other side of that trade."
After Draghi announced a 1.1 trillion-euro ($1.2 trillion) bond-buying program on Jan. 22, holdings by euro-area residents of debt and equity in the nine European Union countries outside the currency bloc soared to fresh records, ECB data show. Total portfolio investments rose more than 9 percent in the first quarter to 2.05 trillion euros.
The movement of cash had the effect, not unwelcome at the Frankfurt-based ECB, of helping push the euro down against currencies including the Swedish krona, Poland's zloty, the Czech koruna and the Hungarian forint. Most dramatically, the Swiss National Bank on Jan. 15 preempted the ECB's decision by abandoning its cap on the franc.
While ECB officials have repeatedly said they don't target the exchange rate, they've acknowledged that a weaker euro helps revive the economy and inflation by boosting exports and pushing up import prices. The single currency has dropped almost 7 percent on a trade-weighted basis this year and since the ECB started considering new stimulus has dropped to the weakest in three months.
The flipside is that countries seeing their currency strengthen face downward pressure on inflation rates already suppressed by falling energy costs. Swedish inflation is at 0.1 percent compared with a target of 2 percent. Denmark and the Czech Republic are at 0.2 percent. Consumer prices are declining in Switzerland, Poland and Hungary.
With euro-area prices also stagnating and the ECB considering whether more stimulus is needed, countries that have eased policy this year face having to do so again, even if unwarranted by domestic conditions.
Swiss real-estate prices remain risky, according to a measure by UBS Group AG, yet SNB President Thomas Jordan has said the deposit rate could fall further from the current minus 0.75 percent. The central bank will hold its quarterly policy review on Dec. 10, exactly one week after the ECB's next meeting.
Swedish property prices have risen almost 50 percent since 2009 and gross domestic product is growing twice as fast as the euro area, yet looser policy may be coming. Deputy Governor Per Jansson said last week that the Riksbank is moving closer to intervening in the currency market, with little scope to cut interest rates further or buy more government bonds.
"The more the ECB does in terms of quantitative easing, the more the Riksbank needs to do in order to avoid the Swedish krona becoming too strong," said Par Magnusson, an economist at Swedbank AB in Stockholm.
In Denmark, unemployment is below 4 percent and the price of owner-occupied apartments rose 10 percent in the past year -- yet action may be needed if the krone's peg to the euro is to be maintained.
To summarize this process, the eurozone countries have borrowed too much money and now can't grow under the weight of their debts, so are devaluing the euro. This sends a deluge of hot money pouring into nearby countries, forcing the relative value of their currencies up to dysfunctional levels. In effect, the eurozone is exporting its deflation to its neighbors.
The victims have no choice but to respond in kind, easing their monetary policy even in the face of fast growth. The result: a race to the bottom in which every currency loses value against real things. And -- because deflation is gaining rather than losing momentum in most major economies -- the process is just beginning. Which means some truly unique things are going to happen in 2016. Here, for instance, is Sweden's version of the Fed Funds rate over the past year:
Assuming the ECB eases some more, which it will almost certainly have to given 1) the political rebellion against eurozone austerity and 2) European inflation, which is falling back below zero...
...the non-eurozone victims of the currency war will become something historically unique: an entire region where negative interest rates are the norm and cash is either discouraged or banned.