The rhetoric in the emerging global currency war, or as we have dubbed it ‘the ugly race’, has stepped up recently. Finance Ministers from some emerging market economies have become increasingly vocal in their stand against unconventional policy measures such as quantitative easing that they interpret as unduly impacting upon foreign exchange markets. For the moment, this distaste has only resulted in increasing rhetoric. There is the risk, however, especially if growth disappoints, that government words might turn into action. Leaders could even raise the stakes beyond currency intervention, perhaps eventually adopting import tariffs and other trade barriers. Such an outcome would be damaging to the global economy at the best of times. Given the still-fragile state of the recovery, it would be particularly unwelcome now.
More than three years on from when the Federal Reserve announced its first QE programme, emerging market economies are increasingly making their voices heard. South Korea has called for the upcoming G20 meeting, due to be held in Moscow next month, to focus on the adverse consequences of the substantial monetary easing enacted by the world’s major central banks. According to its finance minister, Shin Je Yoon, ‘there are growing concerns over inflation [in those countries pursuing unconventional monetary policy]’. Calling for greater international coordination, he urged that measures seeking to influence international capital flows “should be recognised as common policy tools’. The South Korean won has appreciated steadily against the US dollar, rising some 10% over the past six months. This not only hurts South Korean exports, but also harms the won-denominated foreign earnings of multinational companies such as Samsung and Hyundai.
Seoul is not alone. Je Yoon’s opposite number in Brazil, Guido Mantega, initially coined the phrase ‘currency war’ two years ago when the Federal Reserve approved its second round of QE, which resulted in a quite rapid appreciation in the real. More recently, Mantega has criticised The Fed’s decision in September to expand its asset purchase programme as being ‘protectionist’. The First Deputy of Russia’s Central Bank has since echoed these statements. Adding fuel to the fire, he recently claimed that we are ‘on the verge of very serious and confrontational actions in the sphere, which is, not to get too emotional, called currency wars’.
Policymakers in advanced economies have rejected criticism that their actions have had unfair costs on emerging market economies. Fed Chairman, Ben Bernanke, speaking in October, said that it was not at all clear that accommodative monetary policy in advanced economies imposed ‘net costs’ on emerging markets. He did admit that interest rate differentials had shifted in favour of emerging economies and had thus ‘probably contribute[d] to private capital flows to these markets’, however, he suggested that capital flows were likely to be more reflective of the relative difference in growth prospects. He added that policymakers in some emerging markets had chosen to ‘systematically resist currency appreciation as a means of promoting exports and domestic growth’.
Worry over a global currency war is not confined to policymakers in emerging markets. Bank of England Governor, Sir Mervyn King, said in December that he feared more countries would look to artificially deflate their currencies as a way to boost growth, adding ‘you can see month by month the addition of the number of countries who feel that active exchange rate management, always of course to push their exchange rate down, is growing’. Nevertheless, he has been accused of talking down the pound and recently referred to a recent rise in sterling as not being. Among the advanced economies, Switzerland has been one of the most active participants in foreign exchange markets. Since September 2011, its central bank, the SNB, has maintained a floor of CHF 1.20 against the euro, promising to purchase foreign currency in ‘unlimited quantities’ in order to defend it.
The euro has risen some 10% against the US dollar since the middle of last year, however, this strength, which primarily reflects increasing investor confidence in the future of the single currency, has not been universally welcomed. The Prime Minister of Luxembourg, Jean-Claude Juncker, recently described the euro as being “dangerously high”. Some European leaders might see a cheap currency as a way for the peripheral Euro Area economies to boost trade and competitiveness. However, Germany, the region’s economic powerhouse and major exporter, may be the country best placed to benefit from such an occurrence. Data released earlier this week showed that, despite a global slowdown and double-dip recession in Europe, net trade contributed 1.1 percentage points to German GDP growth in 2012, more than accounting for the overall 0.7% rise.
Given its outward-looking multinationals, and reliance on net trade as a source of growth, Japan has often meddled in currency markets in attempts to drive down the yen. Previous efforts pale, however, to what its new Prime Minister, Shinzo Abe, has in mind. Reports suggest that the BoJ may be involved in a mooted public-private investment fund tasked with buying more than $500bn in foreign securities. The BoJ has already doubled its inflation target to 2%, following pressure from the new government. The yen has depreciated markedly since Mr Abe’s election victory and is currently trading at its lowest level against the dollar since mid-2010.
Faced with wide-ranging weakness in domestic demand, it is not surprising that economies are looking at alternative ways to boost growth. However, attempting to talk down one’s own currency as a means of escaping a period of globally weak demand is, of course, a zero-sum game. It may even be dangerous. We hope that recent heightened rhetoric is more posture than planning. Following the stock market crash of 1929, the US Congress passed the Smoot-Hawley act, which raised tariffs on a wide range of imports. The bill was intended to spur the domestic economy, but the US’s main trading partners soon retaliated with tariffs of their own. Far from boosting growth, these protectionist policies significantly dented world trade and unnecessarily deepened the Great Depression. Three years on from the worst economic crisis since then, it is to be hoped policymakers have learned from previous mistakes.