The finance ministers and central bankers of the G20 group of advanced and emerging economies meet tomorrow in Moscow. Top of the agenda: currency wars.
Now, grumblings about some countries working to push down their exchange rate to boost exports aren’t new. China’s artificially low renminbi was a hot topic of the last U.S. election. On the other hand, the Fed’s lax monetary policy, which has kept the value of the greenback relatively low since the recession, has been irking emerging economies. Yet, life went on.
Why the big deal about exchange rates now? In a word: Japan. Shinzo Abe is back for a second term as prime minister and he’s vowed to end once and for all the spell of deflation that’s plagued Japan for the last decade and a half — whatever it takes. The plan is for the government to embrace massive spending and the Bank of Japan to target a two per cent inflation rate (that’s the level of inflation deemed ideal here in Canada too but for Japan to get there form its currently negative inflation, the BoJ will have to print money like mad.) All of this will ( and, in fact, already has) push the value of the yen down, helping Japanese exports.
Unsurprisingly, some people suspect Abenomics, as Japan’s new economic agenda is known, is nothing but a cover for currency manipulation. Traders and the media have been crying foul.
Never mind that Switzerland has openly declared war on the appreciation of the Swiss franc and nobody seemed to care. They’re too small to matter (cheaper imports of Swiss chocolate and watches apparently do not threaten any big domestic industry anywhere else). Japan, the third-largest economy in the world, is a whole different matter.
And Abenomics has become a major source of disagreement between rich and developing countries at the G20. While the latter view Tokyo’s moves suspiciously, the first have, for the most part, welcomed the government’s efforts to revamp the Japanese economy.
Here in Canada, Bank of Canada governor Mark Carney has been a vocal supporter of PM Abe’s plans. Carney’s position, which he articulated in Davos last month, is that Japan’s policies are aimed at fixing the domestic economy. Of course monetary policy has spillover effects on the exchange rate (see here why) but… well, that’s really too bad.
Obviously, that doesn’t mean Carney condones currency manipulation. In fact, he spent a fair amount of time yesterday in the House of Commons explaining to Canadian MPs why tinkering with the loonie is simply a bad idea. Canada is committed to freely floating exchange rates, he concluded, and the task at hand is to bring emerging economies on board with this too.
Witness the same line of thinking at work behind the communique released yesterday by G7 countries (Canada, the U.S., the U.K., Japan, Germany, France and Italy). It reads:
We, the G7 Ministers and Governors, reaffirm our longstanding commitment to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets. We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates (…)
Get it? Triggering a currency depreciation is cool, as long as you don’t do it on purpose.
Now, there’s undoubtedly some legitimacy to the rich countries’ argument. After all, most developed economies will need to pursue very stimulative monetary policy for a while longer to continue to support the recovery — and it should be in their right to pursue this important and strictly domestic objective.
But things can get blurry pretty quickly. Recent comments by some Japanese ministers about the depreciation of the yen have triggered alarm bells in the rest of the G7 that Abenomics might be perceived as stealth currency manipulation. The legitimacy of Abe’s plan almost seems to hinge on the ability of the government to avoid mentioning the exchange rate. It’s easy to see how emerging countries could interpret this as another ploy of the West to impose a new double-standard: currency wars are only OK when waged à la Shinzo Abe or à la Ben Bernanke. China and its old-style currency manipulation, on the other hand, deserve a slap on the wrist.
This would be a dangerous misperception. Floating rates are good, and capital controls are bad (and largely ineffective). And a number of advanced economies do need to continue to stick to very stimulative monetary policy for the next little while. But other countries and the markets must continue to believe the intent of such policies isn’t to drive exchange rates. If they believe that, exchange rates will remain relatively stable, and we’ll all be fine.
Convincing emerging economies that they should move toward freer currency markets and, at the same time, put up with the side-effects of temporary monetary stimulus in the West is the tricky task people like Mark Carney face at the G20 meeting tomorrow.