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Currency Wars: A New Found Facet

 3 min read / 

Just as the US Federal Reserve has stopped buying bonds, ending its quantitative easing program, the Bank of Japan went in the opposite direction by announcing the ramping up of asset purchases, with Japanese government bonds the hot topic at the moment. Interestingly, it sent the yen to a seven year low of ¥112 per dollar. Another player, the European Central Bank also revealed days ago a liquidity injection plan worth €1tn that was tallied with a drop of the euro to below $1.24. A remarkable coincidence, or rather a strategic plan?

A two faced objective

“Currency wars” is not a new term. It describes a country’s policies that lower the exchange rate in order to increase the competitiveness of the economy. A weak currency leads to a fall in the real price of exports thus making them more attractive on an international level. Economic growth is the primary objective. Now is the time to perhaps include the other facet of this strategy: the avoidance of deflation. Low exchange rates also happen to push import prices up, bringing inflation back to where it should be, with the mantra of the 2% target, shared by both the Bank of Japan and the European Central Bank.

A case of Japan 

Monetary expansions with the aim of weakening the yen are a strong element of Japan’s Prime Minister Abe economic undertakings. It comes as no surprise that Haruhiko Kuroda, Governor of the Bank of Japan welcomed a lower exchange rate by hinting at a possible extension of the nation’s stimulus program a few weeks ago. That possibility became reality.Japan is still a global leader in both production of cars and machinery, competing with the likes of South Korea and Germany. Reviving the economy from the decade lost through cheaper exports is a perfectly viable solution, however one that seems to be on the verge of testing the strength of a few relationships.

Toyota, the world’s biggest car manufacturer has for instance just raised its net profit forecast for the year to ¥2tn from ¥1.78tn, projecting a second successive record breaking year. On the other side of the spectrum, the weaker yen threatens the price competitiveness of Hyundai Motor overseas. The potential ramification of a game involving competitive currency depreciation is not a pretty sight. Targeting the lack of inflation will be irrelevant if such a game induces a drop in the price of consumer goods.

So, what next?

An evolution resulting from weak price growth pressing world economies has occurred. Currency wars may result from countries, such as Japan, targeting inflation through imports rather than growth through exports but exchange rates have not changed in nature. A currency’s weakness is still another’s strength. While this zero-sum relationship exists, any benefit a depreciating country could gain will potentially be short lived as competing nations can retaliate with similar measures.

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