Currency Depreciation as Monetary Policy

December 2, 2014Monetary Policyby Marc Chandler

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Are countries depreciating their currencies to boost growth?

Megan Trainor tells us it is "All About the Base".  It seems like many reporters and analysts may be mistaking her lyrics as it is all about debase, as in currency wars. 

The latest surge of currency war stories follow the unexpected decision by the Bank of Japan to dramatically increase its Qualitative and Quantitative Easing at the end of October.  It was the same week that the Federal Reserve announced the end of its asset purchase operations.  Since the BOJ's decision, the yen has depreciated by 8.3%.  

There has been little push back from the international community.  Nothing from the G20, the G7 or the US Treasury.  Even South Korean rhetoric has been fairly circumspect.  By a unanimous decision, the central bank left rates on hold a couple weeks after the BOJ's move.  The minutes of the South Korean central bank showed one member warning that concerns about the weak yen and deflation are exaggerated.  Another recognized that the impact of yen's depreciation on Korea has been limited. 

South Korea did cut rates in October, but this was before the Bank of Japan's move.  After denying the need to provide broad economic support, the PBOC cut the one-year deposit rate for the first time in two years.  Although the move surprised many investors, there was little if any doubt that the PBOC was motivated by domestic issues, including softening inflation and falling house prices. 

Like China, monetary policy developments in emerging Asia is driven primarily by domestic variables.  Several countries, like Philippines, Malaysia, Indonesia, and India were in a tightening mode, but are now seen on hold.  Taiwan and Singapore have been on hold for an extended period.  When the monetary stance changes, it will be because of domestic price pressures and the growth outlook. 

Some observers are worried about a repeat of the 1997-98 Asian financial crisis.  They argue that that crisis was precipitated by the depreciation of the yen.  At the time, many Asian countries had dollar liabilities and yen receivables.  This mismatch is not nearly as pronounced now.  The reason is that rise of China.  China is the largest trading partner of most of emerging Asia.  Ironically, the close link of the yuan to the US dollar serves to minimize the volatility of the region's currency mismatch. 

Ambrose Evans-Pritchard, the International business editor at The Telegraph recognizes that the launch the BOJ's aggressive monetary policy experiment did not trigger a currency war, despite many claiming otherwise because the yen was significantly over-valued.  This is not the case anymore, which is why he is worried that "Japan risks Asian currency war with fresh QE blitz". 

Indeed, the OECD's measure of purchasing power parity shows the yen to be now under-valued by 14.5% against the US dollar.  It is the most under-valued of the major currencies.    On the eve of Abe's election two years ago, the OECD estimated the yen was about 23% over-valued.  By the OECD's reckoning, the yen is the most under-valued in nearly 30 years.  

This may seem to help explain why the launching of QQE in April 2012 did not spark a currency war, but it does shed light on why there has been little or no resistance to the BOJ's latest efforts.  Could it be that Japanese exports in volume terms are roughly flat?  Could it be that Japanese businesses are not taking advantage of the weak yen to boost market share in foreign markets? 

Many observers seem to confuse means with ends.  The goal is not a weaker currency to boost exports. The goal is to stimulate the economy and arrest deflation.  It is not a race to debase, but an effort to provide monetary support for an economy that has reached the zero bound, and one in which fiscal policy is largely exhausted (Japan's debt is over 230% of GDP).  This was one of the concerns that Moody's expressed when it cut Japan's debt rate to A1, which is below the rating agencies assessment of China.  

Countries have to be free to pursue the monetary policy that is required by its domestic economy without being accused of starting a currency war.  Many countries face slow growth and weak price pressures.  They could seek to drive their currencies lower.  This could be a zero-sum exercise if it results in simply taking the aggregate demand from its trade partners.  Alternatively, countries can respond by stimulating their own domestic demand via monetary and fiscal policies and structural reforms that boost potential growth.

All About Debase: Not is republished with permission from Marc to Market

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