On Thursday, the European Central Bank (ECB) is widely expected to expand its already highly aggressive quantitative easing program. It will do so in an attempt to kick-start Europe's anemic economic recovery and to stave off the risk of deflation. While the ECB will present its action as an appropriate monetary policy response to a weakening eurozone economic recovery, the main channel through which its actions will work will be a further significant depreciation of the euro. While this might be good for the European economy, it will impose a substantial burden on the rest of the global economy.
Since ECB President Mario Draghi announced in September 2014 that the ECB would engage in quantitative easing to support the European economy, the euro has depreciated by more than 20 percent against the U.S. dollar. He is now strongly intimating that the ECB will step up its 60 billion euros a month bond-buying program and will extend it beyond September 2016, when it was due to expire. This will almost certainly exert substantial downward pressure on the euro, especially since it coincide with the likely start of a Federal Reserve interest rate hiking cycle.
Among the more important reasons to be concerned about the ECB's likely action is that it will exacerbate the global payment imbalance problem. That, in turn, could set up the stage for disorderly exchange rate movements down the road. Already in 2015, the European economy is expected to run a record external current account surplus of around 3.5 percent of gross domestic product (GDP), while Germany will record a record surplus of around 8.5 percent of GDP. Any further depreciation of the euro is bound to increase these surpluses, especially considering that the full effect of the large euro depreciation over the past year has yet to work its way through the system.
Equally disturbing is the impact that further euro depreciation will have on the beleaguered emerging market economies, which to date have been the main engine of global economic growth. Generally, a weakening of the euro against the U.S. dollar has been associated with lower international commodity prices. At the same time, a lower euro has the effect of causing emerging market currencies to depreciate further against the dollar. This is the last thing that the emerging markets need now, considering how very heavily their corporate sectors have borrowed in dollars over the past few years of easy global liquidity conditions. According to the Bank for International Settlements, since 2008, emerging market corporate borrowing in dollars has increased by over $3 trillion and now constitutes a significant risk to the global economy.
A further significant euro depreciation could also pose a particular challenge to China as it tries to revitalize its economy. For political reasons, especially in a U.S. election year, Chinese policymakers cannot allow their currency to depreciate very much against the dollar. As a result, any further euro depreciation against the dollar would undermine China's international competitive position. This is certainly not what China needs as it struggles to rebalance its economy.
The net upshot is that further aggressive ECB policy action could have unintended adverse global economic consequences. For this reason, it would be preferable if attempts to revitalize the eurozone economic recovery focused on more expansive fiscal policies by those eurozone countries, especially Germany, that have the policy room to do so. However, if the past is prologue to the future, I would not suggest holding your breath waiting for this to happen.
Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.