The currency wars

The currency war: now and then

Global currency wars worries have resurfaced in recent weeks, mainly because of Japanese action on the yen. In order to understand the meaning of this so-called war, we would have to go back in time to the 1930's. Back then, the currency wars scared economists as they had a big part in the Great Depression in the 1930's. The damage done to global financial markets in that period took several decades to repair, and a repeat of this nightmare cannot be ruled out completely. However, there are large differences between the 1930’s and nowadays and the results of what is happening may differ as well. In the past, it seems like currency wars were defined as any policy that is intentionally designed to drive down the value of a currency, whether by local inflation or an exchange rate decline. It is quite the same thing in the long run since a rise in inflation relative to other countries will eventually be fully reflected in a lower exchange rate.

So what about today's currency wars? The conclusion of what happened back then was that a currency war which results in an equal currency devaluation, along with monetary easing, would probably have been much less damaging than the direct trade and exchange control retaliations which actually occurred in the 1930’s. Currency wars could still develop into direct trade wars, though even if they do not, they could lead to other problems like commodity inflation and asset price bubbles in the emerging economies, though so far, we are not seeing a repeat of the 1930’s.

Goldman Sachs bank support this opinion, stating that "this configuration of asset market moves - the real rate declines, steepening in nominal curves, currency depreciation and the pattern of domestic equity sector outperformance - is  more consistent with a bout of monetary easing that is expected to prove expansionary, rather than a currency war interpretation".

American economist Paul Krugman also believes that what is going on today is all a currency war misconception. According to Krugman, it would be a very bad thing if policy makers take it seriously, as "the stuff that’s now being called “currency wars” is almost surely a net plus for the world economy. In the 1930’s this was because countries threw off their golden fetters, they left the gold standard and this freed them to pursue expansionary monetary policies".

G-20 and the currency war

The Group of 20 finance chiefs sharpened their stance against governments trying to influence exchange rates. Two days of talks between G-20 finance ministers and central bankers ended last week with a commitment not to “target our exchange rates for competitive purposes”. This stance is stronger than the one they took three months ago and might affect Japanese officials to stop publicly giving guidance on their currency’s value. Today the yen is near its lowest level against the dollar since 2010, while policy makers are trying to calm concerns that some countries might be trying to weaken their exchange rate in order to encourage export and by that, the economic growth. According to the G20, and contrary to the opinions of GS and Krugman noted above, the risk is a 1930’s style of devaluations and protectionism. Bundesbank President cited that “Politically-motivated devaluations can’t sustainably improve competitiveness; they don’t solve structural problems and they set off reactions”.

We shall mention Japan once again, as the Bank of Japan Governor Masaaki Shirakawa said: “The Bank of Japan’s measures have been and will remain targeted at achieving a robust economy through stable prices". In the G20 meeting, Japanese officials denied driving down their currency, and according to them, its fall was a byproduct of their effort to accelerate the Japanese economic growth rate.    

More we shall mention that the IMF Managing Director said that the talk of currency wars is overblown, and Federal Reserve Chairman Bernanke said: "the U.S. has deployed domestic policy tools to advance domestic objectives and bolstering the U.S. economy will support world growth".

Economic releases and events of the week

• Monday: Eurozone Finance Ministers Meet in Brussels
• Tuesday: EU-27 Finance Ministers Meet in Brussels, Eurozone Services PMI, Eurozone Composite PMI, U.S. ISM Non-Manufacturing (all for February), Eurozone Retail Sales (January, expected to slightly increase)
• Wednesday: Eurozone GDP 4th quarter (expectations for a decrease of 0.6%), U.S. Federal Reserve Releases Beige Book
• Thursday: ECB Main Refinancing Rate, Draghi to hold a press conference after Rate Decision, U.S. Trade Balance January (expectations for an increase in the deficit)
• Friday: Germany Industrial Production, U.S. labor market data - unemployment rate and Change in Nonfarm Payrolls