Sunday, November 23, 2014

Beggar Thy Currency Or Thy Self?

NEWPORT BEACH – Not many countries nowadays seek a strong exchange rate; a few, including systemically important ones, are already actively weakening their currencies. Yet, because an exchange rate is a relative price, all currencies cannot weaken simultaneously. How the world resolves this basic inconsistency over the next few years will have a major impact on prospects for growth, employment, income distribution, and the functioning of the global economy.

Japan is the latest country to say enough is enough. Having seen its currency appreciate dramatically in recent years, Prime Minister Shinzo Abe’s new government is taking steps to alter the country’s exchange-rate dynamic – and is succeeding. In just over two months, the yen has weakened by more than 10% against the dollar and close to 20% against the euro.

European leaders have already expressed reservations about Japan’s moves. The US auto industry is up in arms. And, a few days ago, Jens Weidmann, the president of the Bundesbank, publicly warned that the world risks a harmful and ultimately futile round of competitive exchange-rate depreciations – or, more bluntly, a “currency war” (a term used previously by Brazil to express similar concerns).

Of course, Japan is not the first country to go down this path. Several advanced and emerging economies preceded it, and I suspect that quite a few will follow it.

It is just over a year since Switzerland surprised many when it announced, and strictly implemented, a threshold beyond which its currency would not be allowed to appreciate against the euro. And, remember, the country’s operating model for centuries has been to provide a safe haven for foreign capital.

One need not be an economist to figure out that, while all currencies can (and do) depreciate against something else (like gold, land, and other real assets), by definition they cannot all weaken against each other. In order for some currencies to depreciate, others must appreciate. Here is where things get interesting, complex, and potentially dangerous.

In today’s world, no significant group of countries is looking for currency strength. Some resist appreciation actively and openly; others do so in a less visible manner. Only the eurozone seems to accept being on the receiving end of other countries’ actions.

None of this is unprecedented, and there is a lot of scholarship demonstrating why such beggar-thy-neighbor approaches result in bad collective outcomes. Indeed, multilateral agreements are in place to minimize this risk, including at the International Monetary Fund and the World Trade Organization.

Yet, when push comes to shove, country after country is being dragged into abetting a potentially harmful outcome for the global economy as a whole. Worse, this process has not yet registered seriously on the multilateral policy agenda.

There are many reasons for this, ranging from the rather debilitated state of multilateral governance to the urgency of domestic issues currently commanding national policymakers’ attention. But there is also something else at work: The causes of today’s predicament are difficult to comprehend and counter effectively.

Unlike the old days, the threat of currency wars is not directly related to trade imbalances and balance-of-payments crises. Rather, an important driver is major central banks’ pursuit of experimental measures in order to compensate for policy inadequacies and political dysfunction elsewhere.

If the world is to avoid serious harm, it is important to understand the dynamics at work. A simplified description runs as follows: Facing low growth and high unemployment, and with other policymakers stuck on the sideline, a central bank like the US Federal Reserve feels that it has no choice but to adopt a highly accommodating monetary policy. As policy interest rates are already floored at zero, it is compelled to venture ever deeper into the uncharted realm of “unconventional policies.”

The aim, as Fed Chairman Ben Bernanke said again in December, is to “push” investors to take more risk. Specifically, it is hoped that an artificial surge in asset prices will make people feel richer and more optimistic, thus triggering “wealth effects” and “animal spirits” that stimulate consumption and investment spending, bolster job creation, and, in the process, “validate” the artificial asset pricing.

In practice, the strategy has proved not to be so straightforward. Moreover, part of the liquidity that the Fed injects finds its way into other countries’ financial markets. Witness the surge in capital flows to emerging markets as investors chase higher financial returns. Complicating matters even more, these inflows have become less and less connected to the recipient countries’ economic and financial fundamentals.

Many investors also feel the need to balance increasingly speculative investments (“satellite positioning”) with much safer investments (“core positioning”). To meet the latter objective, they turn to prudently managed countries, placing upward pressure on their currencies, too – and, again, beyond what would be warranted by domestic fundamentals.

It is no wonder that more and more governments are worried about exchange-rate appreciation. In addition to short-term policy headaches, stronger currencies carry potentially significant costs in terms of hollowing out industrial and service sectors. So, after a varying mix of tolerance and “heterodox” responses, officials are pulled into loosening their own monetary policy in order to weaken their countries’ currencies or, at a minimum, limit the pace of appreciation.

This period of expanding policy inconsistencies could prove to be temporary and reversible if central banks succeed in jolting economies out of their malaise, and if countries come to recognize that greater cross-border policy coordination is urgently needed.

The risk is that the phenomenon leads to widespread disruptions, as increasingly difficult national policy challenges stoke regional tensions and the multilateral system proves unable to reconcile imbalances safely. If policymakers are not careful – and lucky – the magnitude of this risk will increase significantly in the years ahead.

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    1. CommentedRobert Lunn

      I wish one of these esteemed writers would explain how the worst economies, loaded with debt, combined with limited natural resources (as well as many other negatives) not have a weak currency to begin with.
      Debtor nations have debased their currency for a long time essentially "defaulting" on their debt, slowly. With the imbalances not seen since WWII, is it possible markets are responding by strengthening relative currency for high debt nations? Until this recent Japan move, China saw the importance of not importing inflation with a relatively weak yuan. Most of us marvel at the continued strength of the euro/dollar cross.
      Economic thresholds must be at play and I would love to hear the views of these participants.

    2. CommentedKathy Holland

      I think it would be more beneficial to establish a floor to prevent further crippling of our already fragile economies. Although attempting to cap extremes is important too -- not at this point in time. Have to love Bernanke's theory on "encouraging" investors to take on risk....thank you for the chuckle Mohamed.

      You have brought up some really great talking points. No real surprise that quantitative easing showed up outside the U.S.

      Too much attention given to the working parts of economies while turning a blind eye to the wreckage.

    3. CommentedJoshua Ioji Konov

      This is a valuable comprehensive article. The currencies war is not a long term economic solution, whereas only better macroeconomic transmissionability could boost economies.
      Enhancing Markets (i.e. Economies) Transmissionability to Optimize Monetary Policies’ Effect
      Joshua Ioji Konov
      January 26, 2013
      Chicago IL, the USA
      Monetary Policies of expanding liquidity through bottom low interest rate; stimulus packages, quantitative easing, etc should be transmissible to the entire market (i.e. economy) for best performance. However, current markets (i.e. economies) do not posses enough market security to provide the transmissionability to reach adequate market development (i.e. economic growth). This paper theoreticizes that by marginalizing the shady business practices of vague personal corporate liability and contract laws, vague insurance and bonding laws, inadequate intellectual property laws, environmental protection and consumer protection laws , etc will enhance the market security, and will improve the transmissionability and the effectiveness of the Monetary Policies to boost market development (i.e. economic growth).

    4. CommentedGeared Economy

      Indeed we should stop to act like we can beat the other country. It's better to start striving for a new global currency the amount of which is controlled by a new global treasurer. It should be related to the number of people in the workforce, average working hours per week and average hourly labour rate. Wealth doesn't come from monetary tricks and complex mechanisms, wealth comes from efficient and effective use of human labour and resources. See also the theory of the geared economy at

    5. CommentedEdward Ponderer

      Each country continues to act as though it is the sole independent variable in a linear equation. But in per the ancient Greeks, and more recently, Columbus, our world is not flat -- its global. And that fact is now coming to roost in an equation in which no country is a sole independent variable, and things are ever less linear because its not individual economies that can grow any longer, it interdependent coupling that does.

      And this reality can take us to one of two places:

      1 - A transition to a bottom-up behavioral economics of mutual responsibility -- grass roots integral education and societal value development, round table citizenry input in evolutionary cooperative parallel with classical government. This will lead to an organic, holistic, and homeostatic Humanity.

      2 - The catastrophe promised by entropy x deterministic chaos x interdependence coupling = Murphy's Law.

      Higher Mind Humanity, or mindless lemmings to the sea -- that's the choice. For the populous at large, whether as active players or evermore the victims, it will not be a spectator's sport. As to the powers that be, smooth, peaceful transition is always preferable to the swift transition of the guillotine.

      We best all awaken from our stupor...

    6. CommentedJonathan Lam

      Gamesmith94134: Beggar Thy Currency Or Thy Self?

      I once heard Mr. El-Erian said of fundamental and valuation are the basis on measuring the strength and pressure; they are the check and balance in maintaining a sustainable situation and suitable growth.

      The FED and ECB will continue the quantitative easing in buying everything in sight with its fiat money and everyone will earn their money in exchange of Euro-dollar, yen through their entrapment on currency reserves. It is because FED, ECB and BOJ are also entrapped to their dominant currencies that most emerging market nations depended on and also invested in. Perhaps, their outcry of “beggar they currency” signify the demand of change and reverse the position of being invested to remain at their super-currency valuation in such level that causes harm to their fundamental through competitiveness. So, their defense using Quantitative Easing to encounter the emerging market nations reinvest their reserves in the developed nations.

      Perhaps, shouldn’t we question on the strength of dollar, euro, or yen held ever after they had lost their competiveness and sank in black hole of unsustainable sovereignty debts? Why did deficit continue after reminbi rose significantly? However, I think it was the calculation. Because American mistaken the valuation of its dollars earlier when money were flowing in from everywhere credited America for being the consumer of the world; and America forgot the fundamental since corporations made money with no productivity; it is why they are compelled to venture ever deeper into the uncharted realm of “unconventional policies.”

      It was the biggest joke of the century----credit me 1.7 trillion and I’ll be financing the world relatively sound.
      Every change must apply its principle of substitution on fundamental like what, how, who, and why; and such change constitutes an expectation on growth; but its counterpart is the tangible value as in balance as in ratio production and consumption, exchanges on import and export, marginal affordability, long-term and short-term outlooks. At some point, fundamental and valuation interchange through the internal and external transitions. So, we have macro and micro economics, in which, we often examine the compatibility and plausibility through the statistical calculation. However the fine line would fall on the price supportive elements and its bargains throughout the transition like CPI or Currencies exchanges.
      Seriously, we need a new policy on globalization that we go back to the basics refreshing the fundamental and valuation that no one is the designated consumer of the world and only its citizens can validate the asset capital with their currency they have only. Perhaps, we must reinstate the free trade issue that trade applies with goods and services and not money changing hands.

      Eventually, we must face the reality of the currencies that IMF and WTO should make validation on asset capitals that our present throw weight system is not appropriate to the exchange that sounds like a frequent flyer program; and the definition of exchange should be formulate from the currencies of each economy or collective economy which I called Zones that each can sustain an environment of its own. Each can credit on merits and productivity with no fiat money. I may emphasize on the multi-currencies in various grounds and performance in economical development; so, no one is printing more than he earned. Eventually, each nation should maintain its fundamental and valuation with cooperation of its partners; and, each should sustain its balance and equilibrium in an economical sense.

      Like Mr. El-erian said, “The causes of today’s predicament are difficult to comprehend and counter effectively.”
      It is better be late than never to take the reform on the system of currency exchange and create a firewall protection like zoning. The present outlook is very bleak.

      May the Buddha bless you?

    7. CommentedJohnny (MoneyWonk)

      I feel as if you take this view, then you also believe that central banks are acquiescing their independence and funding their respective governments. This is misguided. In the words of Draghi, central bankers are doing “whatever it takes” in order to stabilize aggregate demand and counter deflationary pressures. If anything, central bankers around the world aren't doing enough.

    8. Commentedsrinivasan gopalan

      Currency manipulation or willful weakening of a country's currency is not done just for the heck of it. In fact, a recent joint study by the OECD and WTO has taken the sting out of the tail of the unfair criticism against the Middle Kingdom vis-a-vis its trading partner the United States. When supply chains criss-cross across the universe, it is not Chinese exports per se that escalate the trade deficit because the value-addition to Chinese exports originate from far-off places including in the US as in this case where iPhone is manufactured and traded. It is time that countries succeeding in globalization including China need not be unfairly accused of unfair practices when its high-tech exports have origination across the world. A parallel is the case of India where its software techies as service providers have lent value to the trading of information technology services. It is interesting that like this particular facet of trade, other hidden and embedded values in export products by countries are highlighted by global agencies so that the world would be wiser and begin to think differently to fix problems currently plaguing it on several scores. G.Srinivasan. Journalist, New Delhi Inde

    9. CommentedProcyon Mukherjee

      Hardening of the Euro so early in 2013 is a pleasant surprise, but what economic indicators would be backing that? Similarly Yen devaluation in a matter of sixty days has no physical action behind it so far from the central bank barring the usual 10 Trillian Yen asset buying that BOJ continues to do every month.

      We continue to live in the world of speculation where such articles act as fodder, while economic fundamentals live in the territory of mild-anarchy, to say the least.

    10. CommentedFrank O'Callaghan

      Without dealing with the fundamental issue there can be no solution. Inequality, insecurity and fear will cripple all economies.