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Currency war: Free capital flows increasingly at risk as Fed policy forces Brazil into a “dirty float”

After embarking on a third round of easing last year that only involved extending the length of its zero rate policy and changing the Fed’s Treasury portfolio duration mix, the Fed has recently started QE3 with an even more aggressive tone. It is now targeting the unemployment rate, communicating its commitment to accommodation even after the US economy has picked up. And to do this, it will lengthen asset maturities, buy mortgages, and extend the zero rate policy. This is very aggressive in my view.

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I am decidedly against easy money as a policy tool to reflate moribund economies because it creates distortions central banks cannot control. And these distortions are significant domestically and internationally. In my view, what we are now seeing could be the last vestiges of the forty year system of fiat currency, floating exchange rates and free capital flows. The Europeans now have the euro. The Swiss have a currency ceiling that the Swiss National Bank defends aggressively. The Chinese are pegged to the US dollar. And now even the Brazilians are admitting to a dirty float and currency intervention. That is well over half the world’s GDP in a dirty or fixed exchange rate system right there.

It is only a matter of time before we see capital controls start to form. Either developed economies find growth or capital controls are coming as the currency wars become increasingly acrimonious. I do not subscribe to the view that competitive currency devaluations can work in a benign way. They lead to more intervention and greater friction. The IMF is the only major policy voice warning us of this. It is a warning we should heed.


Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.