‘Currency War’ Is Less a Battle Than a Debate on Economic Policy
Never mind about North Korea; the talk in some quarters is that the biggest threat to Asia and the rest of the world today may very well be a “currency war,” in which countries race to devalue their currencies in a desperate attempt to stimulate growth.
Yet the reality is much different. It is really a debate about how industrialized countries will grow out of their economic malaise, and even the term “currency war” is being misused.
That catchy phrase was first uttered by Guido Mantega, the Brazilian minister for finance, in 2010. What he was referring to was actually something more complicated than countries racing to depreciate their currencies, which is what most people refer to today when they use the phrase.
Instead, Mr. Mantega was really talking about the United States. The huge quantitative easing undertaken by the Federal Reserve has created an environment of low interest rates and put downward pressure on the dollar while pushing the currencies of other countries up.
As they say in physics, every action has an equal and opposite reaction, and the Fed’s actions have pushed hot money into countries, mostly emerging markets like Brazil, with higher interest rates. This creates bubblelike asset prices and spurs inflation.
Normally, the response of Brazil or another such country would be to ease its monetary policy and possibly also lower interest rates in an effort to tamp down demand for its currency. The problem is that Brazil has stubbornly high inflation at 6 percent and can’t respond the way the United States could.
And that is what is really going on with the world’s currencies. Bigger, more mature countries are responding to their own economic downturns by adopting easy money policies. But the problem is that the emerging market economies can’t respond with similar effectiveness because of their own economic or political issues.
Nonetheless, the currency war talk has been revived because of an alarming fall in the value of the Japanese yen, which is down more than 20 percent against the dollar since November. The decline has reaped billions of dollars for hedge funds betting against the currency. It’s nice for these already rich traders, but there will also be yen losers, with potentially bigger consequences.
The slide in the yen is a product of an effort by Japan’s new prime minister, Shinzo Abe, to revive the no-growth, no-inflation Japanese economy that has been mired in stagnation for more than two decades.
Mr. Abe is not only openly advocating an inflationary policy with a 2 percent target, and more stimulus, he is talking down the yen. And this week, Japan is expected to appoint a new head of the Bank of Japan. Whoever that may be is expected to be on board with Mr. Abe’s plan for further stimulus and inflation, a course that is likely to result in further yen depreciation.
As a result, Japanese exports have suddenly become significantly cheaper. And when an exporting powerhouse like Japan devalues its currency that quickly, other nations suddenly find that their goods are much less competitive on the global marketplace.
And once again, the issue is not that every country will depreciate, but how emerging market economies respond. These countries could respond in the easiest manner by letting their currencies appreciate. Many economists would say this is the ideal. Both the United States and Japan would benefit by having a cheaper currency and more growth, while developing nations would benefit by having a stronger currency and ability to buy more goods for consumption.
For many emerging market countries, this is hard to do politically, because it will mean that in the short term, their goods will be less competitive and their manufacturing bases will decline, meaning lost jobs.
Instead, these countries are more likely to try to deal with the yen’s depreciation by doing the exact opposite. They will try to halt the appreciation of their currency. Obviously, economic policy is complicated and economists love to disagree, so the responses of each country may vary, but there are three common policy ways to lower a currency rate: do a round of quantitative easing to expand the balance sheet of the central bank; lower interest rates; or impose capital controls.
The various possible responses show that the currency war is really about genuine policy disagreements between economies over how to address the easy money policies of the bigger industrialized countries, in light of the fact that many emerging market companies cannot respond with the same policies. The European Union has chosen another path by declining to adopt a stimulus approach.
This explains why the world’s financial officials and central bankers have not taken much of a stand.
After Lael Brainard, an under secretary for the Treasury, decried the “loose talk about currencies” and said that the United States supported “efforts to reinvigorate growth and to end deflation in Japan,” financial ministers of the Group of 20 nations released a communiqué.
It stated that their policy was not “to target our exchange rates for competitive purposes” and that “excess volatility of financial flows and disorderly movements in exchange rates have adverse implications for economic and financial stability.”
This followed a slightly different statement from the Group of 7 nations saying that the countries “have been and will remain oriented toward meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates.”
Bland prose like this is typical of these gatherings, yet the Group of 7 appeared to endorse Japan’s efforts. But if you look at the statement from the Group of 20, which includes Brazil and South Korea, it was less favorable, saying merely that there would not be a competitive devaluation. And no surprise, these are the countries most effected by the actions of the United States and Japan.
Ultimately, though, talk of a true currency war, where countries competitively devalue their exchange rates in a zero sum game that recalls the old Matthew Broderick film “War Games,” is overstated. Remember that in “War Games,” just by playing, you lose.
The reason is that even for those countries that can devalue, too much is at stake in this game. Instead, we are more likely to get what Goldman Sachs in a recently released research report called a “global exchange rate mechanism, but in a new noncooperative variant.”
Countries will act within bands based on their options and status, but no one country will take the same tack at the same time because of their different economic positions In other words, a country can’t merely turn on a switch and start a currency war of the sort people are talking about. Some don’t want to, others cannot and the rest are constrained in how they can act.
And while disruptions may happen from time to time, equilibrium is more likely to set in as each country responds slowly. So the currency game will play out in slow motion as each country adopts its preferred approach.
This is a game that has been going on for years. Instead of a currency war, what we are seeing is the everyday problems of a global economy where countries are highly connected and quite distinct.