Remember what happened in the U.S. economy when the financial system was about to collapse? The banks weren’t lending to each other, businesses, or even consumers. The U.S. economy was in a deep economic slowdown. Investment banks like the Lehman Brothers had already collapsed and more would follow. Something had to be done or else it would be a disaster situation.
When all of this was happening, the Federal Reserve stepped in to save the U.S. economy. It started to use a monetary policy tool called quantitative easing. The idea was simple: print money out of thin air and then buy back bad debt from the banks. As a result of this, the banks would have liquidity, which would eventually create more lending, moving the U.S. economy towards the path of economic growth.
You can look at Japan as another example of this. In order to fight the economic slowdown in that country, the Bank of Japan took similar actions to those of the Federal Reserve—I must say, the central bank of Japan has been involved with quantitative easing for a while.
The central bank of Japan wanted economic growth, which was what the Federal Reserve had hoped for in the U.S. economy. Japan’s central bank believed that by introducing quantitative easing, the value of the currency would go down and exports from the country would increase. The Bank of Japan also hoped that the quantitative easing would take the country away from the deflationary period it has been experiencing for some time.
With this in mind, you will come across various arguments. Some will say that quantitative easing has worked in Japan and the U.S., and others will say it has outright failed. Regardless, as the quantitative easing was taking place in the U.S. and Japan, one phenomenon occurred: the value of their currencies declined.
For instance, since March of 2009, the U.S. dollar compared to other world currencies is down roughly 10%. The Bank of Japan took a very strong stance on quantitative easing in 2012; since then, the Japanese yen is down more than 25%.
What’s the point of all this? Quantitative easing may not do what it was originally intended to, but it affects the currency.
While there are concerns it’s all ending now as the Federal Reserve has started to slow the pace of quantitative easing, there’s another opportunity in the making—the euro.
The European Central Bank (ECB) hasn’t outright printed money like the Federal Reserve and Bank of Japan did. The economic slowdown in the common currency region continues to pick up strength. To begin with, the turmoil started in the smaller nations; now the bigger economic hubs are starting to show troubling signs.
As a result of all this, it is becoming a likely scenario that the ECB will go ahead with something similar to quantitative easing.
Let me explain why that is…
Germany, the biggest economic hub in the eurozone, was opposed to quantitative easing, but as the economic slowdown continues to take a toll, we are hearing from the central bank of the country, the Bundesbank—it’s changing its tone. The head of the Bundesbank has said quantitative easing “is not out of the question” in the common currency region. (Source: Bini Smaghi, L., “Reasons to favour eurozone quantitative easing,” Financial Times, March 27, 2014.)
If the ECB goes ahead with quantitative easing, it will create an opportunity for investors, one similar to the opportunity that developed in the U.S. and Japan—a declining currency.
Investors may take advantage of this opportunity that quantitative easing in the eurozone might create by shorting exchange-traded funds (ETFs) like the CurrencyShares Euro Trust (NYSEArca/FXE). If the ECB goes ahead with quantitative easing, this ETF will decline in value, resulting in profits for investors.