What you need to know about the latest threat facing the world's economy - Macleans.ca

What you need to know about the latest threat facing the world’s economy

Why is everyone talking about currencies?


LONDON – The world economy faces a new threat. Instead of a banking collapse or too much debt, fears are growing that countries are using their currencies as an economic weapon.

History suggests that’s never a good thing.

If too many countries try to weaken their currencies for economic gain — sparking a “currency war” — that could stifle business confidence and investment, sow turmoil in financial markets and derail a fragile global economy.

Following their meeting in Moscow this weekend, financial representatives from the world’s leading 20 industrial and developing countries warned that “excess volatility of financial flows and disorderly movements in exchange rates have adverse implications for economic and financial stability.”

Why is everyone talking about currencies?

— Since the start of the financial crisis, central banks around the world have been trying to stimulate their economies by keeping interest rates extremely low. The goal is to encourage consumers and businesses to borrow and spend more. One way central banks drive down rates is to use their power to print money to buy up large quantities of bonds. But by boosting the amount of currency in circulation, there is a side effect: it can drive down the value of that currency relative to others.

As a country’s currency falls, its exports become cheaper, while those of its neighbours become relatively more expensive.

Japan, the world’s third-largest economy, is currently under the harshest spotlight. To get its economy motoring again after a two-decade bout of stagnation, the government has said it would like to see inflation move higher. Markets have interpreted this as a signal that Japan’s central bank is prepared to take actions that would result in driving down the yen, to boost exports and also put upward pressure on prices. Earlier this week, the yen fell to a 21-month low against the dollar and a near three-year trough against the euro.

So is Japan actively trying to weaken the yen?

— Yes and no. Though it’s not directly intervening in the foreign exchange markets by selling yen and buying other currencies, strong comments from the new Japanese government have convinced markets that the Bank of Japan will create more money. Japan’s Finance Minister Taro Aso insists the government isn’t focused on exchange rates, but he has noted that the weakening yen has “brought huge benefits to the export sector” and that the world “has been awed” by the recent surge in share prices.

Why is that bad?

— A falling yen will help exporters, such as Sony and Toyota, and boost Japan’s economy. And it will it tend to push prices – and ultimately wages — higher. But if other countries respond to the falling yen by devaluing their currencies — to maintain the competitiveness of their own exports — Japan will be back to square one and the world economy could suffer.

Sharp fluctuations in the value of currencies can hurt business confidence and investment. Prices for imported raw materials and components would be volatile, profits will be hard to come by as prices fluctuate wildly and the value of any investment a company makes in another country could quickly be wiped out.

Who’s been feeling the effect of Japan’s actions so far?

— The euro, the currency used by the 17-strong group of European Union countries, has seen the biggest move on the foreign exchange markets. As the region moved on from its crippling debt crisis last summer, the euro has slowly gained in value. But since the change of government in Japan, its value against leading currencies such as the yen and U.S. dollar has shot up — last December it was worth 113.19 yen and $1.29 and now it’s at 124.93 yen and $1.33.

A rise in the value of the euro will do little to help the eurozone’s businesses — and will hardly help getting it growing again. Figures Thursday showed that the economic output of the region shrank at an annualized rate of around 2.5 per cent in the last quarter of 2012.

What’s been the reaction from other major economies?

— Politicians have voiced concerns about the euro’s rise versus other major currencies — most notably French President Francois Hollande, who indicated he was open to calls for a more managed exchange rate. European Central Bank President Mario Draghi said last week that the bank will monitor the economic impact of the euro’s rising value. Several analysts took that to mean the ECB could cut interest rates to bolster growth, which in theory could weaken the euro — an indirect tit-for-tat response to the yen’s fall, some say.

Earlier this week, the volatility in the currency markets prompted the Group of Seven leading industrial nations, which includes the U.S, Germany as well as Japan, to warn about the effects of volatile movements in exchange rates.

Might other countries try to manipulate their currencies in response to Japan?

— There is no sign of that — so far. Speaking in Moscow Saturday, International Monetary Fund Director Christine Lagarde dismissed the possibility of an international currency conflict, saying that she was witnessing “currency worries, not currency wars.”

But a country fixing the value of its currency is not without precedent.

In Sept. 2011, Switzerland took action to arrest the rise of its currency, the Swiss franc. The rise was triggered by the debt crisis in the eurozone — investors were looking for somewhere safe to park their cash and the Swiss franc has traditionally fulfilled that role. The Swiss intervention was viewed as an attempt to protect the country’s exporters.

U.S. politicians have for years accused China of keeping its currency, the renminbi, artificially weak in order to industrialize fast. And many countries believe the U.S. long ago abandoned the “strong dollar” policy in a dash for growth.

How bad could a currency war get?

— Since World War II, one of the key objectives of international economic policymaking has been to avoid a repeat of the 1930s, when countries around the world engaged in a tit-for-tat battle with their exchange rates. That decimated global trade, accentuating the depression and providing another catalyst to war.

Assuming the world doesn’t descend into a similar abyss, a currency war can still harm the global economy. For example, central banks, particularly in the developing world, may resort to controlling the amount of capital that can be moved out of a country to affect exchange rates.

“Increasing impediments to the free flow of capital might be thought to lower the potential growth of the world economy,” said Stephen Lewis, chief economist at Monument Securities.

Can the world’s leaders and central bankers calm the situation?

— As many analysts had expected, this weekend’s G-20 meeting in Moscow finished on Saturday with a warning on the dangers of competitive devaluations and a pledge that it will “not target our exchange rates for competitive purposes, will resist all forms of protectionism and keep our markets open.”

The G20 communique — and the G7 statement earlier this week — failed to single out one country’s actions for criticism.

Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University, said that should come as no surprise.

“Many countries including China, Japan and the United States all have issues related to exchange rates,” he said. “People in glass houses should not throw stones.”

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What you need to know about the latest threat facing the world’s economy

  1. According to Krugman this currency war stuff is all nonsense. Japan is printing more money because it has been stuck in a liquidity trap with interest rates below 1% — for 17 years! It has caused government debt to skyrocket to 220% debt/GDP. (The US has 103%, Canada 85%.)

    The only way to deal with that kind of debt is with inflation. Fact is all other Western economies are facing the same liquidity trap (where the interest rate needed to spur a recovery is below zero.) This causes people to hoard money instead of investing it because they expect deflation. The only way to deal with it is with moderate levels of inflation. (Then savers would rather invest their money than see it devalue, which triggers a bull stock market, strong job creation and a full economic recovery.) The alternative is anemic GDP growth, greater debt burden and eventual recession, even depression.

    Currency War Confusions

    • Krugman’s a nut and a hack who got his Nobel and kept his NYT column solely for being vociferously anti-Bush.

      Look at the mess he made as a consultant for Enron in 1999, and then when Enron collapsed in 2001, he pretended he had nothing to do with it. (Google his 2000 column “THE ASCENT OF E-MAN” for a laugh… or a cry).
      At the Times Krugman’s habit of selectively citing numbers and outright lying in his columns forced NYT’s ombudsman Daniel Okrent to adopt, for the first time, a corrections policy for op-ed columnists. He kept Okrents successor, Byron Calame so busy, that he was forced an even more stringent policy just for him 9 months later.

      A dishonest demagogue who gathered a credulous cult following based on his vaguely leftish outlook and outspoken hatred of Republicans rather than his talents as an economist.

      • Paul Krugman is a Nobel Laureate and highly respected macroeconomist among his peers. He most certainly does not cherry pick data to support his position. In fact, he exposes many failed right-wing policies (like austerity in a slump) by showing their premises have been thoroughly discredited by the evidence. He coined the term “zombie economics” which refers to policies that should’ve been killed by the evidence, but shamble along in any case.

        You think Krugman was wrong in criticizing Bush? Under him the economy collapsed requiring trillions in bailouts and stimulus spending to prevent another Great Depression. His reckless tax cuts for the rich are the reason the deficit exploded after the economy crashed and burned.

        Please don’t give me conspiracy theories cooked up by crank Republican bloggers. They hate Krugman because he shows their economic ideology is an abject failure.

        • People should read Kruman for themselves, not listen to what neo-cons have to say about him. Recent Krugman blogs:

          * points out the fallacy that raising minimum wage “kills jobs” (according to the Republicans)

          * shows the “currency war” threat is a fallacy: if all countries devalue their currencies they have the same relative value

          * Debunks the idea that Keynesians run up the debt. Shows that under Keynesian policies America paid down debt from 135% to 35% by the 1970s. It began skyrocketing when Reagan became president on an anti-Keynesian platform.

          * Debunks a right-wing economist’s theory America is facing crisis due to “moral collapse.” Shows teenage pregnancy and crime rate are on a steady decline.

          * Debunks Rubio’s reference to Say’s law: “Every dollar our government borrows is money that isn’t being invested to create jobs.” Uses IMF data of all advanced economies to show that austerity increases unemployment and stimulus creates jobs.

          * Shows Rubio is peddling an outright lie that the Community Reinvestment Act caused the housing meltdown (it was private-sector predatory subprime mortgage lending.)

          This is just the first few blogs. He doesn’t cook any data. The accusation is preposterous.

          If anyone is familiar with his books, they will know he is not a “leftist.” He is a free-market-leaning centrist Keynesian.

  2. What the world needs to know is to stop listening to clowns like Flaherty…who has never in his career balanced a budget. Takes a genius to keep the economy chugging along when you charge billions annually to the taxpayer visa card.

  3. Such an eloquent demonstration of the old saying ‘A little knowledge is a dangerous thing.’

    Does anyone notice the rampant contradiction here – for the last year or more, the Cdn gov has been whining about high debt loads of Cdns – here they say they are keeping interest rates low because people aren’t borrowing enough! – maybe it’s not just a little knowledge that is a dangerous thing, but a complete lack of thinking, just regurgitating whatever witless knowledge the witless ‘authorities’ roll out along with the emperor’s new wardrobe.

    And ‘central banks use their power to print money’ ????? – certainly not in Canada – when the government needs money, it *could* use the Bank of Canada, but has not for the last 40+ years – it allows commercial banks to create credit, which they use to ‘buy’ the bonds from the government (= government borrowing, for those needing things spelled out). Of course, when commercial banks create ‘credit’ to ‘buy’ gov bonds, they charge interest on that ‘credit’ they have just created ‘out of thin air’ by punching some numbers into an account in their computer system – interest which will then have to be paid over the coming years by ‘real’ existing money collected from taxpayers (something like 90% of the $600 billion Cdn debt is simply compounded interest over 30+ years) we’ve paid some two trillion dollars in ‘interest’ on such bonds the last 30 years – money which could have been used for things we needed or wanted (infrastructure, doctors, pensions for old people, etc) as the government cried in mournful tones ‘We’re too poor to do these things! – We must service the debt oh woe oh alas!’. (complete lies, all of it all the time, it’s a massive scam and fraud) (the ‘credit’ when transferred to the accounts of people who wish cash can of course be exchanged for ‘printed’ bills, but it’s a different process, not that difficult to grasp for anyone bothering to do something with their time besides keep up with the latest entertaining but meaningless gossip from Twitter or their local “news” paper or CBC “information radio” show (more properly known as Corporate State propaganda for the CBC demographic).)

    More of considerably more useful interest here for those who’d like to understand things a bit better than from the latest nonsensical corporate canada talking points memos that is all the mainstream media seems to be able to offer – What Happened http://www.rudemacedon.ca/what-happened.html .