This, in a nutshell, is our situation again today. Sterling’s weakness reflects, in part, the exceptional severity of the British slump. But it also reflects the fact that the Bank of England has moved further and faster in the direction of quantitative easing than any other central bank. With the Old Lady buying up British Treasury bonds hand over fist as a way of bringing interest rates down, it is no surprise that sterling should fall. It is no surprise, that is, given the failure of the ECB and the Fed to move as quickly to quantitative easing. And, in the event, this aggressive quantitative easing is precisely the medicine needed by a British economy on life support.
Now the Swiss National Bank has followed suit, announcing a shift to quantitative easing in response to mounting fears of deflation. It implemented that policy last week by buying foreign exchange and corporate bonds, rather than government debt as in Britain, but the net result was the same. It was a sharp fall in the exchange rate, by 3%, on the first day of the new regime.
So sterling and the franc are falling because their central banks are administering precisely the treatment that their economies require. Will other central banks, seeing their own currencies strengthen, conclude that the threat of deflation has grown more immediate and also now move quickly to quantitative easing? If so, exchange rates against sterling and the franc will revert to more normal levels. And, with quantitative easing all around, the world will receive the additional dose of monetary stimulus that it desperately needs.