Japan’s record trade deficit for 2012 announced Thursday will bolster new prime minister Shinzo Abe’s determination to help his country’s exporters by further devaluing the yen through ultra-loose monetary policy. It should also strengthen the voices of those warning against the dangers of a new round of currency wars, and the politicization of central banks whose independence has kept them at bay.
Currency tensions tend to be most pronounced when global growth falters, global imbalances are large and policy options few, as now. Currency war may be an overly dramatic description, but this year holds the potential, if not for all out war-war, at least for dangerously combustible jaw-jaw.
Central bankers in Frankfurt, London and Beijing have been loudest recently in calling out the risks of monetary expansion triggering a round of beggar-thy-neighbor currency devaluations. Their warnings have been echoed from Moscow, Seoul and St. Louis. Last year it was those Latin American countries, notably Brazil, aiming the same criticism at the U.S. Federal Reserve’s third round of quantitative easing, as they had done with its second.
Governments have, on the whole, been disciplined since the 2008 global financial crisis about keeping their worst protectionist spirits in check. True, there has been a new tariff here, a license requirement there, a capital control somewhere else. There is also no doubt that the resolve of governments to coordinate their policy response to the crisis for the good of the common wealth has weakened. Nations are more out for themselves now. Yet the worst evils of protectionism have been avoided.
While the chorus warning against currency wars gets louder, the Group of 20 leading industrial nations also knows that an outbreak of them would not only undermine economic and financial stability, but that they are wars without winners; a devaluation of one currency has to involve the appreciation of another. The G-20 pledged not to undertake competitive currency devaluations. The policy independence of central banks has allowed that pledge to be honored. That is now threatened by the increasing politicization of monetary policy through the widening of central banks’ remits (Exhibit A: Bank of Japan caving into the new government’s demand for hyper-monetary expansion and a hard inflation target).
Loose monetary policy and the currency devaluation that is one of its consequences scarcely seem like like protectionism to many politicians and their voters. Where is the crime in supporting your country’s exporters by boosting their competitiveness and so offseting the impact of a slow global economy?
But not only do beggar-thy-neighbor policies in whatever form become an economic race to the bottom, they are neither victimless nor without cost. Inflation is imported, diminishing living standards to a greater or lesser degree, as Brazil is now finding. Additional strain is put on public finances. Latin American countries, for example, spent $13 billion in the past 30 months intervening in foreign-exchange markets to shore up their defenses against other countries weakening their currencies.
This year could see several new redoubts being thrown up. Royal Bank of Scotland analysts this week identified Malaysia, Thailand, Chile, Sweden and the Czech Republic as five countries with the willingness and capacity to join the fray by intervening in the foreign-exchange markets to defend their currencies against trading partners seeking to depress their own currencies to improve their exporters’ competitiveness.