HOW times change. When the US embarked on quantitative easing in 2009 it was accused of resorting to competitive devaluation. Now the boot is on the other foot. On Friday under new provisions of the 2015 Trade Facilitation and Enforcement Act, signed into law in February, the US Treasury singled out China, Japan, Korea, Taiwan and Germany as potential currency manipulators.
The five are on a monitoring list in a Treasury report to Congress and are described as meeting two out of three criteria that would lead to a process involving enhanced analysis, enhanced bilateral engagement and remedial action if engagement does not lead to policies that address currency undervaluation and trade surpluses.
The criteria include a bilateral trade surplus of more than $20bn against the US, a current account deficit larger than 3pc cent of gross domestic product and foreign exchange intervention amounting to more than 2pc of GDP over a year.
This raises the temperature in today’s so-called currency wars. It must also evoke uncomfortable historical parallels for China and Japan. China in the 1930s was forced off a silver standard when the US Treasury tried to help hard-pressed US silver producers by manipulating the silver price upwards. As China’s currency soared, the peg to silver had to be abandoned. The adoption of a paper currency was followed by one of history’s great hyper rinflations. That in turn paved the way for regime change and the communist takeover.
Japanese Finance Minister Taro Aso made it clear he did not share the US Treasury’s view that the yen market was orderly and suggested that the US initiative would not be a constraint on intervention. So there could be friction ahead
Japan’s experience of yielding to external pressure on currency was less dramatic but painful. The Plaza Accord in 1985 was intended to weaken an overvalued dollar against the yen, the D-Mark, the French franc and the pound. It succeeded all too well. The decline in interest rates that accompanied yen depreciation had the effect of blowing up the great Japanese bubble. The bursting in 1990 heralded the start of the stagnation era in which Japan remains enmeshed.
The curious thing about this war is that China’s currency is arguably overvalued. And Japan’s recent experience demonstrates how difficult it can be to effect a competitive devaluation. When the Bank of Japan announced its move to negative interest rates in January, the yen’s response was to appreciate. And when the BoJ last week failed to satisfy market expectations of yet more easing, the currency appreciated even more.
Part of the reason for the strength of the currency this year was the yen’s role as a haven in the volatile markets of February and March. The interesting question is why the appreciation continued when investors’ risk appetite returned and markets stabilised in April.
The unwinding of carry trades where the yen was used as a funding currency is no doubt part of the explanation. At the same time JPMorgan in Tokyo estimates that Japanese companies have accumulated 50tn yen of overseas retained earnings which they are now beginning to unwind. It also seems likely that the currency is now, as in the 1970s, being driven by a ballooning current account surplus which JPMorgan expects to hit ¥21.6tn — or 4pc of GDP — in 2016.
Unlike Germany, which has no direct control over eurozone interest rates or the euro and can thus run a huge current account surplus of 8.6pc of GDP with impunity, Japan cannot hide.
Given that currency depreciation was the only component of Abenomics to have much impact on the economy, the obdurate appreciation of the yen this year must be a serious concern. And given the size of the current account surplus, the ¥10tn-worth of intervention permitted under the US Treasury’s third criterion would be more pea shooter than bazooka.
At the weekend Japanese finance minister Taro Aso made it clear he did not share the US Treasury’s view that the yen market was orderly and suggested that the US initiative would not be a constraint on intervention. So there could be friction ahead.
Yet the ‘war’ is arguably pointless, for as economists Barry Eichengreen and Jeffrey Sachs showed in papers in the mid-1980s, uncoordinated monetary expansion via supposedly beggar-thy-neighbour trade policies was benign in the 1930s because it increased the global money supply. The difference today, as Japan has found, is that monetary expansion is becoming difficult to pull off even with negative interest rates.
Published in Dawn, Business & Finance weekly, May 9th, 2016
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