It’s time to call an end to the “currency war.”
In 2010, Brazilian Finance Minister Guido Mantega declared the world’s central banks were engaged in a currency war – a race by countries to drive down the value of their currencies to help boost their economies through exports. Ever since he uttered the phrase, the global effort to break free of the financial crisis has been draped in a metaphor of conflict.
The rhetoric shows signs of heating up again, amid forceful moves by major central banks to pump up their economies through the creation of new money. The U.S. Treasury Department said Friday in a report that China’s currency is “significantly undervalued” and that it would “closely monitor” Japan’s aggressive new monetary policy to ensure the goal was economic growth, not a weaker yen. The globe’s finance ministers and central bankers will gather in Washington next week for the semi-annual meetings of the International Monetary Fund. Currencies are sure to be a hot topic.
The invocation of a “currency war” is provocative because it is a reminder of the 1930s, when nations consciously devalued their currencies, leading to a barrage of “beggar-thy-neighbor” policies that stifled global trade, contributing to the Great Depression.
But the war imagery is also unhelpful. It makes calm debate about difficult policy decisions nearly impossible. And almost everyone who is in a position to know believes the war is a myth. “I’ve never liked the ‘currency war’ concept. It engages in hyperbole,” Robert Zoellick, the former World Bank president, said last week at a conference hosted by the Peterson Institute for International Economics, a think tank based in Washington. Although the event was held under the rubric of a “currency war,” the only time the phrase was uttered was to dismiss it as a reflection of reality.
“I don’t think there’s a currency war,” Alberto Musalem, a managing director at Tudor Investment Corp., a Greenwich, Conn.-based hedge fund company that manages more than $11-billion (U.S.) in assets, said at the conference. “I don’t see a deliberate attempt to devalue.”
Foreign exchange markets are shifting. Currencies such as the Canadian dollar are suddenly havens for investors and currencies such as the Thai baht are a play for yield. The primary reason is the growth-seeking, zero-interest, money-creating policies of the United States, Europe and Japan.
Canada, Thailand and others are suffering as a result. If that isn’t war, what is it?
It is more accurately a game of survival in the post-crisis global economy where old formalities no longer apply. The policies of the U.S. Federal Reserve, the Bank of Japan, the Bank of England and others look aggressive because they appear to break the rules. These central banks have created the equivalent of trillions of dollars. What else could this be but a blatant attempt to debase their currencies to give their exporters an advantage in international markets?
If you accept that view, then you think most every policy maker on the planet is a liar, and you deny the validity of an overwhelming body of evidence that concludes that the policies of the Fed and others are doing more good than harm. Even the central bank of Brazil has concluded that its exporters benefit more from stronger growth in the United States than they are hurt by a stronger currency.
The world economy is stuck in purgatory between recession and recovery. The objective of each player is to escape, but none knows quite how to do it. This isn’t a state of war: Nothing is gained by attacking an opponent outright.
But there is an element of survival of the fittest. Countries will do what they can to revive their economies. The contest is complicated by the fact that a handful of players are considerably stronger than the others. But countries have no choice but to play the game.
The world’s major economies spent heavily and reduced interest rates as low as possible to avoid a global depression. Yet there still are 15 million more people unemployed today in the world’s advanced economies than in 2007. With all traditional means of stimulating economic growth having been exhausted, players must be creative and come up with new ways to return employment to pre-crisis levels.
There are no rules, only unofficial guidelines. The Group of Seven industrialized nations have a convention that no member will intervene in foreign exchange markets without the consent of the others. The countries that comprise the Group of 20 say they oppose competitive devaluation and that they will take into account the international implications of their domestic economic policies. The International Monetary Fund monitors the global economy, but only has direct influence over the countries that come to it for bailouts.
THE UNITED STATES
“We are not engaged in a currency war,” Federal Reserve Board chairman Ben Bernanke told U.S. lawmakers at the end of February. “Our monetary policies, which are being replicated in other countries, are increasing demand globally and helping not only our businesses, but also the businesses in other countries that export to us.” Mr. Bernanke’s critics call that a self-serving assessment, but those critics steadily have become fewer in number. Mr. Bernanke is determined to avoid the mistakes of the Great Depression, which he thinks was worsened by policy makers who doubted the power of monetary policy. Still, as the biggest player, there’s no denying the Fed dictates the terms of the game.
The Bank of England has done everything it is legally allowed to do. It dropped its benchmark lending rate to rock-bottom levels, and it has created hundreds of billions of pounds to purchase financial assets, all while letting inflation run in excess of its 2-per-cent target. Yet the economy has been in and out of recession since the crisis. What is a government to do? Change the law. Chancellor of the Exchequer George Osborne rewrote the Bank of England’s remit, calling for “monetary activism,” so long as inflation doesn’t get too hot. Mark Carney, who takes over the British central bank in July, won’t be sitting on the sidelines.
“As the largest foreign holder of U.S. Treasury securities, China is able to influence global currency trends at leisure,” Tuuli McCully, an analyst at Bank of Nova Scotia, wrote in March. If the currency game ever gets truly nasty, it will be because China, the world’s second-largest economy and among the fastest growing, refuses to let the yuan appreciate faster. Much of the capital pressure on countries such as Brazil, Canada and Chile is coming from China, which maintains strict financial controls and a tether on its currency. Yet those countries can’t yell too loudly. China’s demand for the commodities is the main reason they escaped the financial crisis relatively easily.
THE EURO ZONE
The region’s debt crisis put plenty of downward pressure on the value of the euro, as international investors bet the currency union would collapse. It hasn’t, largely because the European Central Bank embraced its role as lender of last resort. ECB officials are adamant that the euro’s value is of secondary concern; their fixation is inflation. The currency’s value, of course, influences inflation. ECB president Mario Draghi commented in early February that the euro’s gains at the time could affect the economic outlook. Traders got the hint. The currency promptly fell the most in seven months.
Japan is hard to figure out. For years, the country’s officials talked about wanting a weaker yen, but only rarely did the central bank or the government attempt to do anything about it. The chatter irritated some trading partners. But for a country that has struggled with deflation for two decades, the willingness to endure an overvalued currency was remarkable. Japan no longer is a passive player. The Bank of Japan will create the equivalent of about $500-billion (U.S.) a year to purchase financial assets until it hits a new inflation target of 2 per cent. The yen has tanked, as Japan has become an inhospitable host for haven-seeking investors. Yet most of its trading partners applaud the move, predicting a revival of the world’s third-largest economy.
Bank of Canada Governor Mark Carney is no complainer: Yes, the policies of the U.S. Federal Reserve have caused the Canadian dollar to rise uncomfortably high, but he says a stronger U.S. economy more than offsets the negatives. Still, he plays the game. “Markets sometimes lose their focus,” he said in October, 2009, a not-so-subtle message to currency traders that he was prepared to make their bet that Canada’s dollar could only go higher a losing one. He also has kept interest rates at 1 per cent or lower for more than four years, in part to offset the loonie’s draw as a haven because of Canada’s relatively solid finances and solid banking system.
Little New Zealand has no choice but to be nimble. It lacks the wherewithal to fight speculative capital flows by creating dollars. “We’d be out in the war zone with a peashooter,” Finance Minister Bill English said in February. Reserve Bank of New Zealand Governor Graeme Wheeler has lowered interest rates, risking a housing bubble. He also said it would be a mistake to view the “kiwi” as a “one-way bet” to appreciate. That suggests he’s willing to intervene to punish short-term speculators. But even Mr. Wheeler admits there’s nothing he can do to stop the broader trend. “Given the strength of recent capital flows, we can only attempt to smooth the peaks,” he said.
Nowhere are tensions higher. North Korea is threatening war. Exporting behemoths such as Samsung Electronics Co. and Kia Motors Corp. are getting hammered by a stronger won. And the government has loudly called on the central bank to weaken the currency. Yet Bank of Korea Governor Kim Choong Soo surprised many this week by leaving the benchmark interest rate unchanged, citing improving economic conditions and an imminent boost from fiscal stimulus. It is possible Mr. Kim is playing a game within a game by asserting his independence from the politicians. If so, it’s a dangerous one. The South Korean economy has grown at an annual rate of less than 1 per cent for seven consecutive quarters dating back to the spring of 2011.
Finance Minister Guido Mantega is one of the wiliest players of the currency game. Move one: Declare a “currency war,” deflecting blame he might take for a struggling economy. Move two: Engineer a near 20-per-cent depreciation in the real over two years through a slew of measures, including taxes on short-term capital, lower interest rates and intervention. Move three: Go to New York, as Mr. Mantega did in February, and declare that the “war” is over, at least for Brazil, where the economy is poised to grow about 3.5 per cent this year, compared with 1 per cent in 2012.
The Swiss National Bank is proving the critics wrong. In September 2011, the SNB pegged the franc to the euro, pledging to create an “unlimited” amount of money to buy foreign currencies. Critics said the Swiss central bank was setting a terrible precedent, courting inflation and instigating a trade war. None of that has happened. Thomas Jordan, the head of the Swiss national bank, said in February that his policies have “nothing to do with a currency war,” and his neighbours believe him. Investors were so eager to flee the euro crisis by seeking safety in Switzerland that they would have crushed the country’s export-driven economy. The SNB has staved off deflation and a recession, although its foreign reserves now are the equivalent of three quarters of gross domestic product.