The G20 twenty meeting had the world’s FX traders holding their breath.
Would currency manipulators be called out for their awful currency war attacks? Would there be censure of Japan and its Yen weakening campaign? Currency manipulation is considered an economic crime because the old orthodoxy says currencies should float and the markets decide.
In the original old, old, orthodoxy it was believed currencies should be fixed. Countries were proud of their strong currencies. Exchange rates were fixed and were defended like a national treasure. A drop in a currencies value was considered like a defeat in battle. In the long term, fixed currency rates were a recipe for trouble because when economic times changed currencies conversion rates need to change as well to keep the economy in equilibrium. If your currency can’t change with shifting economic realities, bad things happen.
However governments love to govern and show off their power, so they loved fixed exchange rates. The people who managed them were raised by this artifice to the role of national champions and defenders of the national economic faith.
Eventually the market won making fixed rates to much trouble to maintain and currencies were allowed to float. Out of the window went fixed exchange rates and currency values were allowed to move and reach equilibriums from one moment to the next.
In a way the euro crisis has been caused by a version of fixed exchange rates. Losing their local currencies for the Euro meant in effect a move to a exchange not related to local economic or social realities. The adoption of the euro, disconnected from the economies of Southern Europe shows just how damaging a non-floating currency can be. The strong Euro gave economically weak countries artificially cheap credit to gorge on, and then saddled them with an exchange rate incompatible with their competitiveness. The fixed nature of the euro, as far as an Italy, Spain or Greece is concerned, was and is also a block on their historic way these countries ran unsustainable deficits, because in the old days deficits would be inflated away in real terms by the devaluation of their currencies.
Back in the world of floating exchange rates, countries wishing to a trading advantage can manipulate their currency to be low and thereby have ultra-competitive prices for export goods.
All the country need do to devalue is buy other countries’ currencies or bonds and pay for them by printing fresh money or of course drop interest rates. By devaluing a currency in a floating exchange rate environment, the result is trade booms and foreign reserves balloon. What’s not to love about that? It is of course inflationary but so what, economic growth often goes hand in hand with inflation.
However everyone can’t do that. If everyone printed money and bought other countries cash with it, exchange rates would remain unchanged and only inflation would ensue.
So in a cooperative G20 kind of world, devaluing your currency to keep you exports cheap is a no-no. It is in effect trade war waged through a currency.
China has been accused of manipulating its currency so that it can continue to suck away the wealth of the developed world. Some think China wants to keep doing that until there is no more to drain.
No developed world govenment can afford to claim this because the west simply cannot make its own goods anymore and borrows much of its money from China just to buy the things it needs from China. China is now the workshop of the world. The west can’t call China a currency manipulator and break ties because it is now a co-dependant in this one sided trade relationship.
Now Japan has woken up to the fact it has been the only country not fighting the currency war and consequentially its industry and economy has been hammered by its over-priced currency.
It is fixing this situation and trying to get the Yen back to a sensible price. This is not popular wityh the rest of the world but it is certainly proving popular on the Tokyo stock exchange where shares are booming.
Devaluing is of course an action that deprives others. When Japan devalues, it makes more money. The jobs it gains are ones that other countries lose. As such no one wants their trading partners to devalue. It’s a trick you want to use, not one you want your competitors to try.
As such using the term currency manipulator is fighting talk.
This is however so deeply ironic that it is almost comical.
We all know interest rates are key to setting currency rates. It is economics 101, that every school child with an economics text book will read. There is a direct connection between interest rates and currency strength. High rates strong currency, low rates weaker currency.
We know categorically that interest rates around the world are manipulated as never before. The central banks are out bending interest rate curves at every opportunity and introducing new ways to do so every few months.
Central banks across the developed world have been manipulating interest rates with abandon.
Manipulating interest rates is effectively the same as manipulating currencies. So the whole issue about Japan or China being currency manipulators is mute.
Everyone is at it.
However while this goes on, we are at last getting to the bottom of the problem. Trade imbalances are the base of the economic iceberg that sank the west and the world economy. Trade imbalances are the tethering link in the chain of causation behind the long recession. The next link is fiscal deficits, the next sovereign debt.
Until currencies are rebalanced the new, new orthodoxy of every increasing money supply pressure to try and restart the flow of economic activity will not solve the problem of developed world growth.
If trade is not balanced the developed world will simply become poorer and poorer at best until it is as poor as China, Russia, Brazil etc.
This might be inevitable, but it is a sobering prospect.