The G20, a group composed of finance department officials and central bankers from twenty developed and emerging market economies from around the world are meeting this weekend in Moscow. One of the main topics of discussion will be the notion of currency wars and the links to fiscal and monetary policy. This whole premise of currency wars though has sparked a fear amongst investors that there will be a period of extreme volatility in exchange rates. Quickly though, the word “war” is far too extreme. It perhaps overhypes the implications of these policies. None the less, measures to spur domestic growth do have direct implications on a country’s exchange rate, and thus are much more far-reaching.
It was earlier this week, when a subgroup of the G20 (known to as the G7) issued a statement that created much confusion and unnecessary conflict around currency devaluation. To summarize, they proclaimed that central banks are permitted to utilize domestic policy measures to stimulate economic growth at home. In essence, they are saying that it is simply okay for policy makers to be willfully blind and not consider the unintended consequences of domestic policy on their exchange rate with nations with whom they trade.
It’s my opinion that the G7’s statement is truly naïve and lacks depth. There is no question that central bankers enacted these policies to spur domestic economic growth. The off shoot, however, is that these policies often devalue their price level and in turn their currency which encourages export led growth. The reason being that when, for example, the US dollar depreciates against the Chinese Yuan, US goods can become cheaper in China as fewer Yuan are required for the purchase. So really, it depends in which context a policy is considered domestic in a global economy.
Japan, for somewhat good reason, has been scapegoated as the villain when it comes to the excessive policy of central banks, but unfortunately for them it is because onlookers have a very myopic view. Furthermore, it is a faux pas for a Prime Minister to intervene in the actions of his central bank and thus has directed a lot of negative attention. That being noted, Japan’s currency has appreciated significantly since the financial crises because the country attracted capital as a result of the lose policy from the US Fed as investors seek a safe haven. They are only attempting to restore balance in their export led economy which has been competing with a strengthening Yen and loss in productivity from an aging population.
None of the above is to act as a defense for the Bank of Japan or the policy actions of other central banks around the world. It is simply fact. Many central bankers are following the actions of US Federal Reserve and the Bank of England such that their currency is not viewed as a safe harbor to attract capital and cut them off from export markets. This is why we have seen countries like Egypt and Brazil be considered as losers because they are or perhaps were strong emerging economies that attracted capital; therefore, their respective currencies appreciated against the US dollar.
These policies, prompted by central banks are primarily intended to encourage investors to put their money back into the economy and invest in equities and businesses. It is to prompt the reinvestment of cash that has been sitting idle for the last four years. What’s unfortunate is that there has to be a cost for all this beyond the notion of currency wars. The US Federal Reserve simply cannot triple their balance sheet to finance the US Treasury’s (aka Federal Government’s) operations without a cost. Same with the Bank of Japan who will tolerate higher levels of inflation by increasing bond purchases financed by expanding their money supply to encourage economic growth. Many are predicting inflation, it could be a credit crunch, it could be an erosion of confidence in the markets, but there’s no such thing as a free lunch.