Tuesday, December 25, 2012

Global Currency Tensions Rise

Economic statecraft, at the Wall Street Journal, "Japan's Abe Calls on Central Bank to Resist Easing Moves by U.S. and Europe":
TOKYO—Japan's incoming prime minister fired a volley into increasingly tense global currency markets, saying the country must defend itself against attempts by other governments to devalue their currencies by ensuring the yen weakens as well.

Shinzo Abe's call comes as others including Bank of England Gov. Mervyn King warn that the world's economic-policy makers risk becoming embroiled in currency spats that could heighten tensions among countries.

Mr. Abe on Sunday called on Japan's central bank to resist what he described as moves by the U.S. and Europe to cheapen their currencies and noted that a yen level of around ¥90 to the dollar—it was at ¥84.38 in early Asian trading Monday, down from ¥84.26 late Friday—would support the profit of Japanese exporters. Tokyo markets were closed on Monday for a holiday.

"Central banks around the world are printing money, supporting their economies and increasing exports. America is the prime example," said Mr. Abe, referring to the Federal Reserve's policy of flooding the market with dollars by purchasing massive amounts of Treasury bonds and other assets.

"If it goes on like this, the yen will inevitably strengthen. It's vital to resist this," said Mr. Abe, who will become prime minister on Wednesday.

Mr. King, in an interview this month, said, "I do think 2013 could be a challenging year in which we will, in fact, see a number of countries trying to push down their exchange rates. That does lead to concerns."

It was part of an effort by countries to preserve trade advantage, he said. "The policies pursued by countries for domestic purposes are leading to tension collectively."
What is notable about Messrs. Abe's and King's comments is that the scope of global currency angst seems to be expanding. China, which manages its exchange rate to keep it closely aligned with the U.S. dollar, has long been the object of global criticism for its efforts to hold down the value of its currency in an attempt to boost exports.

Since the financial crisis, other countries—including Switzerland, Israel and South Korea—have ramped up their efforts to prevent their own currencies from getting too strong amid worries about their export competitiveness. Policy makers in Australia also are under increasing pressure to fight the rise of the Australian dollar.

Global central bank foreign-exchange reserves expanded to $10.5 trillion by mid-2012 from $6.7 trillion in 2007, according to the International Monetary Fund, a 57% rise in less than five years and a sign of how aggressively world central banks are stockpiling other currencies in an attempt to prevent their own currencies from getting too strong in the wake of the 2008 financial crisis.

The largest increase has been in Switzerland.

It is "completely different" for Japanese companies if the dollar is in the 80-yen range, as it is now, as opposed to the ¥90s, Mr. Abe said. If the dollar "is above ¥85, companies that haven't been paying taxes until now [because they don't have profit]…can pay taxes."

The U.S. hasn't explicitly sought a weaker dollar. But the effect of its policies has been to suppress its value. Most notably, the Federal Reserve's quantitative-easing programs—in which the central bank prints dollars to purchase government bonds—have the side effect of holding down the international value of the currency by increasing its supply in global markets.

Despite this effect, the dollar has retained much of its global trading value in recent years because investors are flocking into U.S. Treasury bonds as safe haven investments.

The dollar's value against other currencies is little changed since early 2008, according to a Federal Reserve index, which measures its value versus U.S. trading partners. Over the past decade, however, the dollar has lost 23% of its value versus other currencies.

Some prominent U.S. economists have been pressing the Fed and U.S. Treasury to respond more aggressively to Chinese actions. Fred Bergsten and Joseph Gagnon, economists at the Peterson Institute for International Economics, estimate that the U.S. trade deficit would be $150 billion to $300 billion smaller—and the U.S. would have two million more jobs—if China and other emerging markets didn't intervene to protect their currencies.

They have called on U.S. policy makers to retaliate, by intervening in markets to hold down the dollar or by taxing imports from these countries.

Low-interest-rate policies and quantitative-easing strategies like the Fed's are one way to suppress the value of a currency. Another is currency intervention—in which a central bank sells its own currency and buys another. South Korea's central bank in November sold won and bought at least $1 billion in the currency market to curb a steep rise in its currency, traders said, and its officials warned against "excessive" moves that would hurt the nation's exporters.
This isn't good. The report goes on to note that currency manipulations like this generally precede trade wars, like those of the interwar period, which in turn helped contribute to the downward spiral of the world economy during the 1930s. It's fascinating. Also interesting is that the U.S. government's ability to print money to buy government bonds is a privilege --- the "exorbitant privilege" --- that no other government has. Most of world trade is denominated in dollars, so if the U.S. runs massive deficits it's able to finance these with monetary interventions. Needless to say this helps fuel the kind of hostility the Wall Street Journal highlights.