Shinzo Abe was first elected prime minister of Japan in September 2006. He showed commitment to fiscal policy reforms, including a balanced budget, but failed to improve the economy. With a popularity rating below 30 percent, he was forced to resign in 2007, having served for less than a year. Between 2007 and 2012, the yen appreciated by 25 percent.
Abe became prime minister again in September 2012 with a renewed determination to prop up the economy. It seems that he has learned from his first experience on how to improve the economy. He has leaned on Japan’s central bank to devalue the yen to promote exports and achieve higher economic growth. He has debased the yen against the dollar by about 20 percent in the last four months since late 2012. This depreciation has raised the specter of currency wars among the major world economies. How does this recent yen depreciation fit within the feared currency wars?
They say death is one but has multiple causes. Currency depreciation weakens the currency, but it occurs in multiple ways. Abe has used the economic targeting approach in the hope of turning deflation around and moving economic growth up. The target in this Japanese case is nominal GDP, which includes both inflation and output volume. The prime minister has targeted both inflation and output to kill deflation and economic stagnation. The casualty of this nominal GDP is the yen. By following this indirect intervention, Japan is not being accused of practicing currency manipulation.
On the other hand, the European Union has been alarmed by the recent increases in the value of the euro against the yen. The European Central Bank has talked down the value of the euro by hinting that it may take a future action to discourage speculators from betting on a future rise. This European option, which is known as jawboning, sometimes has a little discernible effect on the currency.
The United States has also pursued economic targeting since 2009 by practicing quantitative easing, and the casualty has been King Dollar, which has depreciated significantly against the world’s major currencies — particularly the euro and yen — in the last four years. The Federal Reserve has targeted the long-run interest rate in order to stimulate business investment and increase economic growth. Brazil has accused the U.S. of currency manipulation, which is not exactly the case. Still, using expansionary monetary policy to achieve macroeconomic objectives and having the dollar as a casualty is viewed as indirect currency manipulation, even if the country publicly claims it is committed to strengthening its own currency. The world also wants higher economic growth to help lift the global economy, and the U.S. can do this job. American exports have been the second engine of economic growth in the U.S., second to consumer demand. This second engine is needed particularly in the absence of the traditional growth in the housing sector, which is usually the first to grow when recession ends.
On the other hand, China has been accused by the U.S. of currency manipulation for keeping its yuan low relative to the dollar. The same charge has been leveled against China by Brazil — another BRICS fellow — and South Korea, which both compete with China in the world economy in terms of exports. The manipulation charge against China has been easier to formulate because the currency manipulation has directly dealt with the foreign exchange market. It is considered a sort of blatant manipulation of its own currency to keep it low. This fell short of the usual blatant intervention in the currency market, which amounts to selling one’s own currency to weaken it and buying foreign currencies to strengthen their values. This manipulation of buying foreign currencies to weaken the domestic currency has recently been practiced by the Swiss and Israeli central banks.
China enacted currency controls such as imposing taxes on foreign capital investments in its bonds and other securities and managing interest rates to reduce the demand for its currency and prevent it from appreciating relative to competing currencies. China used currency controls to keep its renminbi (yuan) undervalued relative to the dollar to maintain its competitive export advantage. Other BRICS countries, which include Brazil, Russia, India, China and South Africa, imitated China. Strongly growing Brazil pursued currency controls while raising its interest rates to fight inflation. In South Korea, regulators audited lenders working with foreign currency derivatives with the objective of decreasing currency appreciation caused by the capital inflows associated with these transactions. In Peru, a reserve requirement tax, which is a type of control on capital inflows, increased three times. In Thailand, the government initiated a 15 percent withholding tax on capital gains and interest payments on foreign holdings of government bonds. Interestingly, at the last G-20 meeting, Russia came out against stimulating the economy through currency devaluations. Its finance minister said, “We believe countries should not be competing through their currency policies. They should be competing based on their economic activity.” Russia sees that flexible exchange rate as the way to avoid devaluations and has also committed to achieve this target in 2015.
The engagement in monetary nationalism to achieve economic objectives at the expense of home currency may lead to serial devaluations by other countries. This beggar-thy-neighbor policy is a kind of protectionism that leads to currency wars, which may turn into trade wars. Protectionism is a barrier to global trade, which had been a nontraditional source of high economic growth in the world economy. Currency wars can also destroy the forward exchange market, which provides fuel to global trade. The forward contacts are designed by large banks, which should be affected badly in the currency wars. Citizens can also experience a reduction in their standard of living as their devalued currency loses purchasing power when spent on imports or used when traveling abroad.
Will the currency wars involve major currencies like the U.S. dollar, yen and euro? In this case, the dollar will be sought after because it is considered a safe haven during crises. It should appreciate, taking with it all the currencies that are anchored to it. This includes the yuan and the currencies of the major oil-exporting countries in the Gulf. The other commodity-exporting countries may also feel the negative impact of a stronger dollar on the prices of their commodity exports. Oil, in particular, is a commodity currency and is highly sensitive to changes in the value of the dollar. Gold, which is considered a refuge currency, should benefit from currency wars. Central banks and institutional investors buy more of it during wars, whether currency or military. If commercial banks have problems in the forward currency markets, their shares and importers should feel the pressure.
What will happen if many countries in the world devalue their currencies? We will go back to where we started, but only after inflicting severe damage on global trade and the world economy.
In currency wars, there are no winners because the competitive devaluations are a race to the bottom. Therefore, such wars are short, as was the case in 2010.
Shawkat Hammoudeh is a professor of economics at Drexel University. He can be contacted at [email protected].