Sunday, January 20, 2013
Everybody gets hurt in a currency war
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

A point that is not often made about the long period since the global financial crisis struck is that the world has behaved pretty well in these difficult times.

Beginning with the big G20 (Group of 20) meetings in 2008, countries decided co-operation was better than confrontation. The feared mass outbreak of protectionism, one of the great errors of the 1930s, never happened.

It is as well that it did not. World trade has slowed even without new trade barriers being erected. 2012 looks to have been one of those rare years when world trade grew more slowly than world GDP (gross domestic product). Normally trade grows roughly twice as fast.

Before we congratulate ourselves too much, however, we should keep an eye on what Simon Derrick, chief currency strategist at Bank of New York Mellon, describes as an outbreak of currency wars.

There is more than one way of skinning a cat in times when growth is hard to come by. Protectionism is one. Currency manipulation, often harder to detect, is another. And now we are seeing it.

Much of the focus so far has been on Japan, under its new Liberal Democratic Party prime minister Shinzo Abe, elected late last year. Earlier this month he unveiled a 10.3 trillion yen (£72bn) stimulus to boost the moribund Japanese economy.

But he also signalled what many saw as an explicit attempt to drive the yen lower, in order to boost exports, by urging the Bank of Japan to adopt a looser monetary policy and a higher inflation target.

Abe was pushing at an open door. The yen had already weakened significantly in the final few weeks of the outgoing government, also following a clear lead from the authorities that they favoured a lower exchange rate.

So what? Why should not Japan, which needs all the growth it can get - and some inflation to break out of its deflationary trap - not engage in a deliberate depreciation of its currency? Isn’t this its affair?

Well no, as Derrick points out. Deliberate currency depreciation is counter to the pledges that countries, including Japan, have made in the G20 not to do it. Not only that but one country’s competitive advantage is another’s loss.

South Korea, Japan’s big competitor in electronics, cars and other products, has seen its currency, the won, rise 22% against the yen since last summer. A Hyundai executive described the won’s rise and yen’s fall as “a double-torture situation”.

While describing it as “smoothing operations”, the governor of the Bank of Korea confirmed last week that it has been intervening to try to restrain the won’s rise.

A battle among two of Asia’s most formidable exports does not yet amount to a full-blown currency war but the danger is that it is heading that way.
There are only three big currencies in the world, the dollar, the euro and the yen, with sterling coming in fourth.

European officials appeared relaxed about the euro’s rise since the summer. A stronger euro could be seen as a vote of confidence in the single currency’s survival; market approval for the European Central Bank’s monetary “bazooka” - its outright monetary transactions - and Germany’s more conciliatory attitude towards Greece.

Lately, though, European leaders have been getting restive. The euro’s climb includes a 14% ascent against the weak yen, a fact not lost on German exporters who often have to compete head to head with their rivals from Japan.

Jean-Claude Juncker, head of the eurogroup of eurozone finance ministers, said on Wednesday that the single currency’s rise had taken it to “dangerously high” levels. With domestic demand depressed across the eurozone, exports have been seen as the escape route from its problems. But a sharp slowdown in the German economy to 0.7% growth last year, with a fall in GDP in the final quarter, suggests growth from that source is fading.

Everybody, it seems, wants a weak currency. America, despite its currency quarrels with China, has quietly been pursuing a weak dollar policy since the crisis began, the Federal Reserve under Ben Bernanke ensuring the dollar stayed low with repeated bouts of quantitative easing (QE).

The dollar’s average value is 12% lower than it was before the crisis. Its average value in 2012 was a huge 31% down on its level of a decade earlier.
America’s weak dollar policy has had repercussions. Brazil was one of the countries which protested, and took action, when the effect of Washington’s QE was to push its currency, the real, lower.

Switzerland, caught between the race to the bottom between euro and dollar, established a ceiling for its currency against the euro, and intervened to make it stick.

Britain is not immune from these skirmishes. On Thursday, the pound dropped below 1.20 euros for the first time in nearly 10 months, mainly as a result of the euro’s strength but also because of worries over the the potential loss of Britain’s Triple-A sovereign debt rating and the size of the current account deficit.

There were times when the pound’s fall would have been regarded as bad news. Indeed, there were times when it would have led to a rise in interest rates to defend it. These days it is different.

Sir Mervyn King said in November that sterling’s rise last year was “not a welcome development”. Introducing the latest inflation report, he said: “It may be unreasonable to expect anything other than a slow and protracted recovery absent a further fall in the real exchange rate.”

The Bank should be careful what it wishes for. Though Britain’s large current account deficit - more than £50bn last year - argues for a lower pound, and some of sterling’s safe-have appeal has been wearing off - a lower pound is no panacea.

Indeed, the response of Britain’s trade to sterling’s 25% fall over the course of 2007-8 can only be described as disappointing. Add in that a lower pound undoubtedly contributed to higher inflation, pushing up both industry’s costs and squeezing household incomes. Sterling’s fall was a big factor in the unprecedented weakness of consumer spending in this recovery.

Some countries, including Japan where the ongoing danger is deflation not inflation, are better placed to benefit from a lower exchange rate. But there is one clear and simple fact. All currencies are relative to each other. It is a logical impossibility for everybody to have a lower currency.

Competitive devaluations, as we have seen, cause tensions. The danger is that those tensions lead to a full-blown currency war. That has to be avoided.