Wednesday, February 13, 2013

Currency wars—why Japan's spat with BoJ matters

There is a good reason why, generally speaking, it doesn't make a whole lot of difference what political party is in power or what they claim to believe about economics.  In any country.  That reason is the "independence" of the central banks.  And while central banks cannot do that all much about spurring prosperity, they are really, REALLY, good at bringing misery and wrecking things.  And since the 1970s, the world's central banks have decided that the only task they think worthwhile is "price stability"—which means that at the first sign of an outbreak of generalized prosperity, they feel the need to choke if off in the name of fighting inflation.

This is why what is happening in Japan may be the year's (decade's?) most important economic story.  The 1980s saw a real estate bubble (and several other kinds) sweep Japan.  And when that all went pop, Japan withdrew its newfound economic muscle behind a wall of conservative conventional wisdom. Sure they tried a little economic stimulus here and there but these minor outbreaks of economic activity were soon stifled by the folks at the Bank of Japan.  By 2006 (or so) the BoJ had not only achieved price "stability" in Japan, but had engineered a nasty little outbreak of deflation.  The global economic system of banking and markets were delighted and rewarded BoJ's diligence by making the Yen one of the strongest currencies in the world (only the Swiss Frank and the Norwegian Krone are in the same league.)

Be careful what you wish for.  "Price stability" has led to a serious deflation trap and the powerful Yen has all but wiped out Japan's ability to compete in the global markets—even though the quality of Japanese goods remain world-class.  But there has been an election and Japan's new prime minister Abe has gone to war against all the sacred ideas dear to the cold hearts of central bankers.  He reasons correctly that it is impossible to change the economy until he first changes the policies of the central bank.  He's gone after the BoJ's independence.  He is actually calling for higher inflation.  And he wants to drive down the value of the Yen.  In short, he is trying to kill the holy trinity of central banking's sacred cows.  The howls of outrage will surly be heard in the heavens.

Abe will be condemned for initiating a currency war.  But how exactly do you drive down the value of a currency?  In the past, the best way was to anger the gnomes of central banking.  With Japan, this might not be enough because people will still want to buy their Lexus and Canon video gear.  The markets may thoroughly disapprove of Abe slapping around the BoJ, but they will still need yen in their portfolios.  Japan isn't Ghana, after all.

Currency war

From Wikipedia, the free encyclopedia

Currency war, also known as competitive devaluation, is a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency. As the price to buy a particular currency falls so too does the real price of exports from the country. Imports become more expensive. So domestic industry, and thus employment, receives a boost in demand from both domestic and foreign markets. However, the price increase for imports can harm citizens' purchasing power. The policy can also trigger retaliatory action by other countries which in turn can lead to a general decline in international trade, harming all countries.

Competitive devaluation has been rare through most of history as countries have generally preferred to maintain a high value for their currency. Countries have allowed market forces to work or have participated in systems of managed exchanges rates. An important episode of currency war occurred in the 1930s. As countries abandoned the Gold Standard during the Great Depression, they used currency devaluations to stimulate their economies. Since this effectively pushes unemployment overseas, trading partners quickly retaliated with their own devaluations. The period is considered to have been an adverse situation for all concerned as unpredictable changes in exchange rates reduced overall international trade.

According to Guido Mantega, the Brazilian Minister for Finance, a global currency war broke out in 2010. This view was echoed by numerous other financial journalists and government officials from around the world. Other senior policy makers and journalists suggested the phrase "currency war" overstated the extent of hostility. With a few exceptions such as Mantega, even commentators who agreed that there was a currency war in 2010 generally concluded that it had fizzled out in mid 2011.

States engaging in competitive devaluation since 2010 have used a mix of policy tools, including direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing. While many countries experienced undesirable upward pressure on their exchange rates and took part in the on-going arguments, the most notable dimension of the 2010-11 conflict was the rhetorical conflict between the United States and China over the valuation of the yuan. In January 2013, measures announced by Japan which are expected to devalue her currency sparked concern of a possible second 21st century currency war breaking out, this time with the principal source of tension being not China versus the US, but Japan versus the Eurozone.

Reasons for intentional devaluation

Devaluation, with its adverse consequences, has historically rarely been a preferred strategy. According to economist Richard N. Cooper, writing in 1971, a substantial devaluation is one of the most "traumatic" policies a government can adopt – it almost always resulted in cries of outrage and calls for the government to be replaced.[1] Devaluation can lead to a reduction in citizens' standard of living as their purchasing power is reduced both when they buy imports and when they travel abroad. It also can add to inflationary pressure. Devaluation can make interest payments on international debt more expensive if those debts are denominated in a foreign currency, and it can discourage foreign investors. At least until the 21st century, a strong currency was commonly seen as a mark of prestige while devaluation was associated with weak governments.[2]

However, when a country is suffering from high unemployment or wishes to pursue a policy of export led growth, a lower exchange rate can be seen as advantageous. From the early 1980s the International Monetary Fund (IMF) has proposed devaluation as a potential solution for developing nations that are consistently spending more on imports than they earn on exports. more
Of course, the official calls condemning competitive devaluations are as predictable as the dawn.

US urges G20 to avoid competitive devaluation

Posted: 12 February 2013

WASHINGTON: The United States on Monday urged the Group of 20 economic powers, which holds a meeting later this week, to avoid competitive currency devaluation that would threaten economic growth.

"To ensure growth strategies in the world's largest economies are mutually compatible and promote global growth, the G20 needs to deliver on the commitment to move to market-determined exchange rates and refrain from competitive devaluation," said Lael Brainard, the Treasury official who will lead the US delegation to the meeting.

Japan's recent monetary easing has stoked fears, especially in Europe, of a currency war between the major economies as policymakers seek to devalue their currencies to make exports more competitive.

Brainard, the Treasury under secretary for international affairs, notably called on China to do more to let the yuan float more freely in the market.

"It will be important that China... reinvigorate the move to a market-determined exchange rate and interest rates," she said.

Brainard was speaking at a news conference focused on the G20 finance chiefs meeting that opens Friday in Moscow.

She underscored that some emerging-market economies have tightly run exchange-rate regimes with extensive capital controls.

"The asymmetry in exchange rate policy creates the potential for conflict" and "generates protectionist measures," she noted.

She also called on Beijing to improve its adherence to international trade rules.

The United States regularly accuses China, which had a record US$315 billion trade surplus with the US in 2012, of favouring its state-controlled businesses and subsidizing exports.

Saying that global growth was still weak after the 2007-2009 financial crisis, Brainard warned against complacency and recommended avoiding any severe budget adjustments.

"We must avoid jeopardising the recovery with a premature shift to restraint," she said.

One-third of the G20 advanced and emerging-market economies, which represent almost 90 per cent of the global economy, were in recession, she said.

Brainard said that the International Monetary Fund's recent admission that it had underestimated the impact of austerity plans on growth should raise a red flag when policymakers look at making budget cuts.

"The G20 has to do a better job balancing medium-term fiscal consolidation with the imperative of supporting near-term growth," she said.

"We need to do more to get people back to work."

As for the United States, Brainard said that big across-the-board spending cuts due to take effect March 1, known as sequestration, pose a serious threat to the country. Without an agreement in Congress to avert the cuts, the Defense Department budget will be cut by up to 10 per cent.

"It's important to avoid sequestration, which is a blunt and indiscriminate instrument that poses a serious threat to national security, domestic priorities and the economy, she said. more
And here are the big guns.  Japan's move against her central bank horrifies the Germans.  It makes Japan much more competitive in the capital goods markets—one of Germany's most important economic bright spots.  More interestingly, it tramples on the "rules" of central bank independence and because of the way Germans are taught their history, this is considered just plain evil.

(I'll bold the sections where this German article objects to heresies in their monetary religion.  This thing is a monument to German conventional wisdom.)

Calls for Cheap Euro: ECB Caught in Currency-War Crossfire

By Martin Hesse and Anne Seith

Central banks around the world are trying to cheapen their currencies in order to boost their economies. This is making the euro more expensive and endangering the recovery of Europe's stricken economies. But the European Central Bank is resisting growing calls to join in the currency war.

Billionaire investor George Soros and French President François Hollande, a Socialist, are in agreement: The world is on the verge of a currency war, and it threatens to destroy Europe.

The Europeans should finally enter the fray and do battle with all their might, says Soros, who made some of his fortune by betting against the British pound. "Europe is an outsider," the 82-year-old recently said at the Davos World Economic Forum. He blamed the European Central Bank (ECB), which he called the last representative of an outdated central bank policy.

Hollande doesn't put it as clearly, but he means the same thing. "A currency zone must have an exchange rate policy, or it will end up with an exchange rate that doesn't correspond to the actual state of its economy," the Socialist told the European Parliament in Strasbourg last week.

These remarks were intended for Mario Draghi, the president of the Frankfurt-based ECB. Hollande's message is that he should protect the euro's exchange rate. The central bank chief is coming under increasing pressure because he can't quite bring himself to embrace the concept of quantitative easing, the latest fashion in the world of finance. It involves central bankers engaging in the large-scale purchase of bonds issued by their governments and other securities, thereby injecting huge sums of money into the financial system. In this way, they hope to stimulate the domestic economy and keep their own currencies cheap, thereby strengthening exports. Soros believes that this is the only way countries can grow out of their large debts.

But a country that artificially pushes down its exchange rate is obtaining competitive advantages at the expense of others. And if they manipulate their own currencies, all sides will end up losing out.

Japan has taken the most aggressive approach so far. Under pressure from the newly-elected government, Masaaki Shirakawa, the governor of the Bank of Japan, has announced plans to buy up unlimited amounts of government bonds and securities in the future. The country is in the process of "boldly rebuilding" monetary policy, Prime Minister Shinzo Abe declared. Indeed, the Japanese yen has lost 12 percent of its value against the dollar in the last two months.

The US central bank, the Federal Reserve Bank, has also been printing money to a previously unimaginable extent since the financial crisis. Calling its efforts QE 1 and QE 2, the Fed has pumped more than a trillion dollars into the US economy.

For years, China has defended its currency by pegging the exchange rate to the dollar, and the Swiss National Bank now only permits appreciation of the franc up to a certain limit, because investors have viewed the Swiss currency as one of the last safe currencies since the outbreak of the sovereign debt crisis in Europe.

A "tsunami" of cheap money is rolling across the world, Brazilian President Dilma Rousseff said more than a year ago. The consequences are disastrous for emerging economics like Brazil, because their currencies steadily appreciating in world markets.

But Europe too could end up as one of the big losers. Since the euro crisis has abated a little, the exchange rate for the common currency has appreciated, which could thwart an economic recovery in the continent's crisis-stricken countries. Efforts to make the French economy more competitive could also be in vain, Hollande warns.

But how should Europe defend itself? In theory, central banks are supposed to fight inflation. But the more money they print, the less it will eventually be worth -- a painful experience that Germany, in particular, had to make in the last century. For this reason, Bundesbank President Jens Weidmann issued an especially vociferous warning against a "politicization" of exchange rates and "alarming violations."

ECB President Draghi doesn't want to take part in the global depreciation race either. True, the ECB repeatedly launched programs to buy up government bonds during the euro crisis, to Weidmann's dismay. But they seem tiny by international comparison, and apparently Draghi has no intention to go any further. He sees no reason for a change of course, he says, "just because other central banks are changing."

On the other hand, someone standing in the middle of a battlefield eventually has to defend himself. "Otherwise the euro exchange rate would explode," says Jörg Krämer, chief economist at the major German bank Commerzbank. But if the conflicts escalate, there can only be losers, he added. "We would experience an international devaluation race," Krämer warns. "This would invariably go hand in hand with constantly rising inflation rates and a damaged global economy."

There is probably only one solution to the problem: an international peace treaty between the generals in this new war, the international central bankers.  more
Of course, not everyone is convinced that Japan is wrong to change their macro economic game plan.

Japan's Economic Minister Made An Unheard-Of Comment To Juice The Stock Market — And It Just Might Have Been Genius

Joe Weisenthal | Feb. 11, 2013,

Japan's stock market is going nuts today.

The Nikkei is up 2.3%

The main reason?

This weekend, Japan's economic minister Akira Amrai said that it was a goal for the Nikkei to hit 13,000 by the end of March.

Japan's market has already been on a mega-tear, and now the economic minister is aiming for another 17% rally by the end of March?

We have no recollection of a senior economic official in a developed economy saying anything like this before.

So is it smart? Felix Salmon says it's worth a shot, based on wealth effect argument.

I like this move: it shows imagination, and the upside is much bigger than the downside. The worst that can happen is that it doesn’t work, and the stock market ends up doing what the stock market would have done anyway; the best that can happen is that it helps accelerate the broad recovery that everybody in Japan is hoping for this year.

But in addition to raising asset prices, it does something else, it makes the government look economically reckless. That's a good thing.

Already the new PM Shinzo Abe has taken several steps down this path, including his goal to have the Bank of Japan be subsumed by the Ministry of Finance, a violation of the cherished principal of central bank independence.

Why is this a good thing? Because when you're in a deflationary trap, the economy becomes a victim of the central bank's credibility. People don't believe that inflation can be left to run, because they assume that the central bank will put a clamp down as soon as things get going.

As Paul Krugman recently explained to us in an interview, Japan is solving that, by committing to be irresponsible.

The 13,000 pronouncement furthers that goal. An inflation target here. Unlimited QE there. A Nikkei target here. Suddenly people believe that the government is going to put the pedal to the floor and let things run a bit.  more
This article is about what happens when someone's god dies.  The guys who have been running BoJ have to be these small-minded toadies who hide their intellectual cowardice behind some rulebooks.  So when the rules change, they must change or go.  In this case, I am sure this central banker was encouraged to take up some old-age hobbies.  Because if there isn't a public cleansing of the old true believers, the new ideas will look temporary.  Abe (and the economic interests behind him) want this ship turned around!

Japan's Top Central Banker Wants To Step Down Early, And Markets Are Absolutely Thrilled About It

AP | Feb. 6, 2013

TOKYO (AP) — Asian shares rose Wednesday as Japan's benchmark surged to its highest level since Sept. 2008 though wariness over corporate earnings pulled European indexes lower in early trading.

The Japanese yen's slide to a three-year low on news the Bank of Japan governor will resign early spurred a 3.8 percent jump in the Nikkei 225 stock index. It gained 416.83 points to 11,463.75 as export shares soared on expectations of stronger sales thanks to the yen's slide against other major currencies. Toyota Motor Corp. jumped 6 percent, Honda Motor Corp. added 3.3 percent and Sony climbed 3.8 percent.

The Japanese yen was trading at 93.68 yen per U.S. dollar, its lowest level in almost three years after BOJ Gov. Masaaki Shirakawa said he will step down three weeks early, for logistical reasons. Some investors took it as sign that whoever replaces Shirakawa will be likely to comply with pressure from the government to ease monetary policy to help stimulate economic growth.

Shirakawa said he is stepping down in tandem with his top deputies on Mar. 19 instead of when his own five-year term ends on April 8 and that his decision was not motivated by political pressure. But the central bank has been perceived as resisting pressure for more drastic monetary easing, despite its agreement last month to set a 2 percent inflation benchmark as demanded by Prime Minister Shinzo Abe. more

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