Saved by Zero? Fresh Round of Currency Wars Brings Threat of Deflation

As many countries continue to struggle with weak growth, Central Banks are turning to the standard approach to boosting activity; they are deliberately devaluing the currency.

By weakening a country’s currency against other currencies, the expectation is that demand for exports from the country with the weaker currency will increase. On the surface this makes perfect sense as the currency of the buying nation will be worth more of the seller’s currency thereby encouraging increased sales.

The big fly in the ointment here is that not every country can have the weaker currency. And as competing Central Banks commit to maintaining low rates or even further reductions to gain an advantage, the threat of deflation becomes all the more real.

But what happens when you get to zero and still feel the need to go lower? The European Central Bank has essentially had a negative rate for several months now but the outlook has not improved and there is little optimism for sustained growth in the near term.

Indeed, several European countries including Germany are offering bonds with negative interest. On a 5-year bond for example, the bond holder will actually receive less than their original investment!

This underscores just how pessimistic the outlook remains in Europe. Government bonds are considered the safest investment option and typically offer lower rates of return but still find buyers. Of course the level of security depends on the country but Germany is certainly leader in the Eurozone.

The fact there is any demand at all for these bonds demonstrates the degree of concern for European economies as buyers are willing to pay an extra premium for a higher degree of preserving at least the bulk of their investment.

Scott Boyd has been working in and writing about the financial industry since the early 1990s and has worked with several of Canada’s leading financial institutions.