In the wake of the 2008-2009 Great Recession, central banks around the world entered unchartered territory when they began quantitative easing, the long-term purchasing of securities such as Treasuries and mortgage-backed securities (MBS).
Quantitative easing pumps money into the financial system as central banks stave off a complete collapse of the banking system. The flood of cash lowers interest rates in the hope that growth returns.
In 2009, the U.S. Federal Reserve was the first central bank to begin purchasing securities. As interest rates fell, so did the U.S. dollar. In the month preceding the announcement of QE1, the U.S. dollar index (DXY) fell 10 percent - its biggest monthly fall in over a decade.
Following the COVID-19 pandemic in 2020, the combination of multi-year COVID lockdowns, supply-chain disruptions, aberrations in the oil markets, a disconnect in real economically driven employment vs "The Great Resignation" and aggressive Fed tightening of monetary policy has created the illusion of an overheated economy in danger of growing too fast.
For more than a decade prior, however, economists' greatest fear was that the Fed didn't have enough tools to fend off a weakening economy. Having lowered interest rates to nearly zero, the last strategies to employ seemed to be currency manipulation or the relatively new concept of quantitative easing" (QE).
- In the wake of a financial crisis, central banks can employ quantitative easing (QE), or purchasing various types of securities in the market, as a stimulus.
- QE effectively adds new money to the economy by creating the funds used to purchase those securities, which also helps stabilize markets.
- Currency manipulation is an effort to tinker with the value of a nation's currency about foreign currency exchange rates to boost exports in international trade or reduce its debt interest burden.
- Currency devaluation can lead to trade wars and backfire on the country trying to undertake it.
Currency Manipulation—How and Why All the Fuss?
As it turns out, currency manipulation is not that easy to identify. As one Wall Street Journal blog post puts it, “Currency manipulation is not like pornography—you don’t know it when you think you see it.” Policy action that favorably affects a country's exchange rate—making exports more competitive—is not in itself evidence of currency manipulation. You also have to prove that the value of the currency is being held artificially below its actual value. What’s the true value of a currency? That’s not easy to determine, either.
In general, countries prefer their currency to be weak because it makes them more competitive on the international trade front. A lower currency makes a country's exports more attractive because they are cheaper on the international market. For example, a weak U.S. dollar makes U.S. car exports less expensive for offshore buyers. Secondly, a country can use a lower currency to shrink its trade deficit by boosting exports. Finally, a weaker currency alleviates pressure on a country's sovereign debt obligations. After issuing offshore debt, a country will make payments, and as these payments are denominated in the offshore currency, a weak local currency effectively decreases these debt payments.
Countries around the world adopt different practices to keep the value of their currency low. The rate on the Chinese yuan is set each morning by the People's Bank of China (PBOC). The central bank does not allow its currency to trade outside of a set band over the next 24 hours, which prevents it from any significant intraday declines.
A more direct form of currency manipulation is intervention. After the appreciation of the Swiss franc during the financial crisis, the Swiss National Bank purchased large sums of foreign currency, namely USD and euros, and sold the franc. By moving its money lower through direct market intervention, it hoped Switzerland would increase its trade position within Europe.
Finally, some pundits have argued that another form of currency manipulation is quantitative easing.
Quantitative easing (QE), considered an unconventional monetary policy, is just an extension of the usual business of open market operations. Open market operations (OMO) are the mechanism by which a central bank either expands or contracts the money supply by buying or selling government securities in the open market. The goal is to reach a specified target for short-term interest rates that will have an effect on all other interest rates within the economy.
Quantitative easing is meant to stimulate a sluggish economy when normal expansionary open market operations have failed. With an economy in recession and interest rates at the zero-bound, the Federal Reserve conducted three rounds of quantitative easing, adding more than $3.5 trillion to its balance sheet by October 2014. Intended to stimulate the domestic economy, these stimulus measures had indirect effects on the exchange rate, putting downward pressure on the dollar.
Such pressure on the dollar wasn't entirely negative in the eyes of U.S. policymakers since it would make exports relatively cheaper, which is another way to help stimulate the economy. However, the move came with criticisms from policymakers in other countries complaining that a weakened U.S. dollar was hurting their exports. Economists then began the debate: Is QE a form of currency manipulation?
While the Federal Reserve intentionally engaged in a monetary policy action that decreased the value of its currency, the intended effect was to lower domestic interest rates to encourage greater borrowing and, ultimately, more spending. The indirect impact of a deterioration of the exchange rate is just the consequence of having a flexible exchange-rate regime.
The Bottom Line
Currency manipulation and monetary policy like quantitative easing are not the same things. One is interest rate policy-based, and the other currency focused. However, as central banks began their QE programs, one result was the weakening of their money.
Intentional or not, it can be argued that QE is, in some way, a form of currency engineering. Still, in practice, whether it's manipulation that will always be up for debate.