Is This a Currency War?

Yesterday in a further attempt to stimulate their economy, Japan announced plans to increase their asset purchase program. The move was meant to lower rates even further in order to encourage additional lending and risk taking. The program is similar to ones enacted recently by the Fed and the Bank of England under the guise of Quantitative Easing. While it may seem innocent enough for a country to attempt to stimulate their economy, the fact is this doesn't occur in a vacuum. These programs tend to (and are perhaps intended to) lead to depressed domestic currency values and therefore strengthen the values of foreign currencies in relation.

Export oriented countries like to keep the value of their currency down so that their exports are relatively cheaper and globally more competitive. But when major countries ease policy causing their currencies to depreciate, the exports of other countries become relatively less competitive. In order to defend their export sectors, more countries are being forced to join the easing and currency devaluation fray.

Although the ECB hasn't engaged in an outright devaluation, they have eased policy significantly, and the value of the euro has obviously decreased. In response, the Swiss instituted a peg on the lower bound of the Euro-Franc cross of 1.20, via direct market intervention. The US, UK and Japan have enacted unsterilized bond buying, which should act to increase their money supplies and decrease the value of their currencies.

Japan has engaged in outright FX intervention to weaken the yen, typically when it reaches the mid-70s against the dollar. Brazil has instituted a 6% IOF tax designed to discourage dollar inflows and help stem appreciation of the real. China has always sold their currency against dollars to maintain an artificially weak peg. There have been various other instances of intervention and even more of policy easing.

This makes me wonder… When does it end, and what are the effects of all this newly printed currency? Theoretically if everyone were to devalue, we'd end up more or less where we started. But the nominal amount of currency in circulation would remain elevated regardless. This could have unintended consequences such as increased commodity prices and increased capital flows into those countries with tighter monetary policies.

It seems this could lead to higher volatility, inflation and increased uncertainty in the markets, which in turn discourages further investment and detracts from the purpose of loose monetary policy in the first place. Only time will tell but it appears to me at least that the benefits of these weak money policies could be relatively short-lived.

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Comments (24)

Sep 20, 2012 - 4:47pm
UFOinsider, what's your opinion? Comment below:

The net effect of these programs will be increased participation in non-securitized investments, and the de-escalation of obsolete bearocracies. It's more of a "hey, that's a good idea, I'm doing it too" than a war. There's a LOT of factors, but this is the aspect that interests me.

Companies that become flush with cash will eventually put it to use. Gov't agencies with more cash than their participation requires can have their overall funding budgets slashed, a de facto reduction of government. These programs take time, so we probably won't see results for a while until confidence improves.

Ideally, these efforts are coordinated.

Get busy living
  • 1
Sep 20, 2012 - 5:38pm
Kassad, what's your opinion? Comment below:
Xepa:
AS a total noob, my question would be...which countries look like they're pushing back against these practices and/or try to not get involved at all? And does that mean these currencies will get significantly stronger in the wake of a world-wide recession?

This is a very interesting topic; Taiwan is said to have been making moves to sterilize the effects of the open-market operations taking place by central banks around the world, and China is being backed in to a corner in regard to it's RMB peg.

in it 2 win it
  • 1
Best Response
Sep 20, 2012 - 5:47pm
Relinquis, what's your opinion? Comment below:

There is one key factor missing in your description of the motives of central bank action and your analysis of the consequences of these actions... debt... Sovereign, finance sector, corporate and household debt.

Debt motivates actions by central banks and links some of the key countries involved in interesting ways: - Chinese financing of US deficits through purchase of US Treasuries - ECB actions motivated by providing liquidity to their banking sector in various EuroZone countries and supporting government financing of crisis countries in light of their unresolved currency problems - Dealing with private sector de-leveraging in the US and Europe

It is not clear that the primary motivation of these central banks is to lower their currency values in relation to one another for trade purposes, rather it seems likely that providing liquidity for government programmes and seeking (moderate?) inflation/combating deflation in light of private sector de-leveraging might be a more important motivation. In this light, coordinated efforts by these central banks are less like a currency war and are more complementary than we think.

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Sep 20, 2012 - 6:31pm
IlliniProgrammer, what's your opinion? Comment below:

That's fine. But the US needs to also impose an export tax on grain bound for countries manipulating their currency. Japan probably isn't at the top of our list of mercantilist currency manipulators, but in general a resource-rich country like the US can fight mercantilism by imposing export charges to certain countries.

Yes, the law of one price means we can't single out China with too high of a tax. But if it costs an extra fifty cents a bushel to unload a ship, reload a ship, and then ship goods from, say, Korea to China, we can probably impose a 25 cent/bushel charge on grain shipped to China with no ill effects whatsoever. (Except picking up a few extra bucks from the Chinese Communist Party).

It is probably not the best time during a leadership change, but we need to remind China where their food comes from- and which country is preventing them from facing a bread riot not unlike Libya or Egypt. The goal isn't to hurt China but just to get them to stop playing the mercantilist game.

Sep 20, 2012 - 6:41pm
Relinquis, what's your opinion? Comment below:
IlliniProgrammer:
That's fine. But the US needs to also impose an export tax on grain bound for countries manipulating their currency. Japan probably isn't at the top of our list of mercantilist currency manipulators, but in general a resource-rich country like the US can fight mercantilism by imposing export charges to certain countries.

Yes, the law of one price means we can't single out China with too high of a tax. But if it costs an extra fifty cents a bushel to unload a ship, reload a ship, and then ship goods from, say, Korea to China, we can probably impose a 25 cent/bushel charge on grain shipped to China with no ill effects whatsoever. (Except picking up a few extra bucks from the Chinese Communist Party).

It is probably not the best time during a leadership change, but we need to remind China where their food comes from- and which country is preventing them from facing a bread riot not unlike Libya or Egypt. The goal isn't to hurt China but just to get them to stop playing the mercantilist game.

We've argued the politics and economics of mercantalism before from an international trade point of view, so i don't want to rehash that here, but i have a question...

Given the US need for Chinese purchases of it's debt to finance it's deficit, wouldn't a mercantalist approach, as you suggest, be counterproductive? i.e. aren't you basically forcing the Chinese not to buy your debt when you need them to be doing so?

Sep 20, 2012 - 7:13pm
IlliniProgrammer, what's your opinion? Comment below:
Relinquis:

Given the US need for Chinese purchases of it's debt to finance it's deficit, wouldn't a mercantalist approach, as you suggest, be counterproductive? i.e. aren't you basically forcing the Chinese not to buy your debt when you need them to be doing so?

That's why we also need to cut entitlement spending and increase tax rates on US-sourced income going to foreigners. Also we need to cancel our tax treaties, if any, with Asia, get together with Europe, and charge an 80% tax rate on the residents of tax haven countries when it comes to resource investments or any other kind of investing that's tough to do in a tax haven.

Mercantilism is about resources at the end of the day. The US got out of that game, but China, Singapore, and the rest of Asia are dragging us back into it. The good news for the US is that Asia may own our debt, but we own Asia's food.

Sep 20, 2012 - 9:54pm
buyonegetone, what's your opinion? Comment below:
IlliniProgrammer:
That's fine. But the US needs to also impose an export tax on grain bound for countries manipulating their currency. Japan probably isn't at the top of our list of mercantilist currency manipulators, but in general a resource-rich country like the US can fight mercantilism by imposing export charges to certain countries.

Yes, the law of one price means we can't single out China with too high of a tax. But if it costs an extra fifty cents a bushel to unload a ship, reload a ship, and then ship goods from, say, Korea to China, we can probably impose a 25 cent/bushel charge on grain shipped to China with no ill effects whatsoever. (Except picking up a few extra bucks from the Chinese Communist Party).

It is probably not the best time during a leadership change, but we need to remind China where their food comes from- and which country is preventing them from facing a bread riot not unlike Libya or Egypt. The goal isn't to hurt China but just to get them to stop playing the mercantilist game.

wow this post was written at the 5-th grade wsj style and some of these comments (like above) are just as juvenile...where to begin? 1. where did taxes enter the equation? taxes is fiscal policy, the fed sets monetary policy, typically to be counter-cyclical 2. are export tariffs a good thing? um, excuse me while I look up the tens of thousands of books, scholarly journals, etc. citing the deadweight loss to which taxes lead 3. risk of trade war with largest us trading partner 4. useless tripe that china keeps exchange rate low, a weaker us$ will stimulate exports, blah blah and false and false...go research the real value of exchange rates is measured by relative purchasing power parity and the PPP spot rate. In fact, at this rate the renminbi might actually be overvalued against the dollar 5. a weaker US $ may actually INCREASE the trade deficit, it's called the J-curve effect, so while exports increase, imports increase at a greater rate

cheap talking points need to be thought through

Sep 20, 2012 - 10:03pm
IlliniProgrammer, what's your opinion? Comment below:
buyonegetone:
5. a weaker US $ may actually INCREASE the trade deficit, it's called the J-curve effect, so while exports increase, imports increase at a greater rate
In the very short-term, yes, but in the long-term, they will force up the price of goods in the US and benefit domestic manufacturers. They will also help existing manufacturers compete.

These ad-hominems are an unfortunate distraction. Out of curiosity, do you work and pay taxes? Do you grit your teeth at Chinese export subsidies that reduce US tax revenues on manufacturing?

I have no problem with India or Brazil competing against the US on a level currency playing field. I have a problem with China tilting the playing field by currency manipulation. I have a problem with Singapore operating as a tax haven and helping billionaires evade US capital gains tax. I'm just saying we need to have a counterstrategy against countries who cheat at the game of free trade.

Sep 21, 2012 - 11:57am
West Coast FX, what's your opinion? Comment below:
buyonegetone:
4. useless tripe that china keeps exchange rate low, a weaker us$ will stimulate exports, blah blah and false and false...go research the real value of exchange rates is measured by relative purchasing power parity and the PPP spot rate. In fact, at this rate the renminbi might actually be overvalued against the dollar

I'm aware that under PPP these changes to nominal rates shouldn't matter. But PPP holds approximately only in the long run. If governments/central banks didn't think short-term nominal rates mattered, I don't see why the US would criticize China for currency manipulation or the BoJ or SNB would bother intervening.

Sep 20, 2012 - 7:51pm
IlliniProgrammer, what's your opinion? Comment below:
For argument's sake (assuming this policy is desirable in order to avoid rehashing our previous debate) how would you propose moving from the US's current situation to the one you suggest? Surely that entails sorting out your own fiscal situation before engaging in mercantilism, doesn't it? But wouldn't that then negate the currency aspect of the issue and relegate it to one of international trade?
Much (not all) of the "imbalances" are being caused by Asian currency manipulation. If it weren't for China propping up our currency, the USD would be worth about 70 cents on the dollar. And that would be a good thing. We'd see more demand for US manufacturing, we'd see more social security revenues to help fund entitlements, and we'd shift more efficiently from a consumption economy to a production economy.

At the end of the day, money is just paper. Food and resources aren't. And try having a currency without grain. Thank God we control the resources and not China; it's time for us to put our foot down.

Sep 20, 2012 - 8:15pm
Relinquis, what's your opinion? Comment below:

I understand the premise and main thrust of your argument, but in terms of policy today the US is already in debt to China (to some extent). I don't see how threatening that external debt being rolled over is the logical next step even if one accepts your rationale.

I wonder what the policy debate on this will be during the upcoming elections. Could be interesting. It seems to have left the discourse to some extent compared to a few years ago.

Sep 20, 2012 - 10:22pm
moore.max, what's your opinion? Comment below:

I don't think it's so much a currency war as it is some countries fighting a war against economic realities that are uncomfortable, and other countries defending their position in those realities. Japan is a civilian casualty, in my opinion.

In short, the U.S. seems to be undertaking a steady currency devaluation to make exports more attractive (okay....competitive) because they are being massively undercut by China. This one is obvious and well know. To me it sounds like the U.S. (policymakers, fiscal and monetary) has a collective sense of entitlement to a certain level of employment and high wages. After all, the American dream becomes a lot less dreamy if you can't afford it - so policy makers are trying to keep nominal wages high, while attempting to compete with the labour force of China. China is smart and pretty much said, "Ha, we beat you in math and science, we'll get you here too. Whatever you do to us, happens to you in the long run." Sex is amazing until you realize that half of it is getting fucked. Hence, China is the defender, and the U.S. is the self-destructive drunken brother living on the labour market's couch.

How is Japan a civilian casuality? Japan's debt load and deficit spending have been brought to you by the letters "N" and "X". Net exports. When NX get razor thin or even negative, Japan has a harder time financing its own public debt with its own private money. If the yen gets too hot, their public debt collapses. They've taken a back row seat and the driver, the U.S. is starting to go out of control - the countries in the back seat connected to the matter simply by being in competition with them (as a smaller competitor) have to follow suit or lose out period.

,
  • 2
Sep 21, 2012 - 9:25am
UFOinsider, what's your opinion? Comment below:
blastoise:
all of your models are assuming no black swan events :(
I know you're trolling, but it's kind of relevant here LOL
IlliniProgrammer:
we need to remind China where their food comes from- and which country is preventing them from facing a bread riot not unlike Libya or Egypt.
You're in the camp that thinks those events were about food? Dude, no, just not the case at all: are you watching the news? You can debate for better or for worse, but these are revolutionary groups shooting for a coupe de etat.

In the case of China, they're financing a lot of our deficit, and throwing up a glorified tariff will just cause our expenses to go up. I agree that our deficit spending seriously needs to be reigned in. When our politicians take a more holistic view instead of taking turns bashing corporate and social welfare, then we'll move forward, but they're running a debate rooted in the 70's minset. The world, and our system in particular, is radically different and an upgraded approach is needed.

Other countries are simply protecting themselves from our inflationary policy. Why should they bite the bullet when we're simply trying to push our problems onto other people? Central banks understand exactly what QE1+2+3 mean for them and they're trying to avoid absorbing a loss on their asset values caused by our lack of fiscal discipline.

While we're on the subject, I'm pushing a new term: fiscal discipline. It apparently behooves both political parties to make any serious dent in the geometrically increasing debt, no matter if the call their agendas conservative, socialist, progressive or anything else. We're talking 50+ years of decline, and both parties are at least equally guilty, so enough of the politicized terminology: we're going to be disciplined or we're going to pay the price, it's that simple.

Get busy living
  • 3
Sep 21, 2012 - 9:43am
IlliniProgrammer, what's your opinion? Comment below:
UFOinsider:
You're in the camp that thinks those events were about food? Dude, no, just not the case at all: are you watching the news? You can debate for better or for worse, but these are revolutionary groups shooting for a coupe de etat.
The first revolution perhaps was about corruption. But I think the continued unrest and rioting in Egypt and Libya despite the regime changes can be explained by the Egyptian economy's inability to provide enough food security at $10/bushel. Or at the very least, the fact that the median person in Egypt is having trouble making ends meet due to high food prices obviously doesn't help the countries' leaders (whoever they are this week).
Sep 21, 2012 - 12:27pm
sanjose04, what's your opinion? Comment below:

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