The cost of the Sino-US FX deal: Surging money market rates (in Hong Kong)

This is from Financial Times’ FT Fast this morning:

A key lending rate between Hong Kong banks jumped to its highest level since February, potentially making it more expensive to short the renminbi.

The overnight CNH-Hong Kong Interbank Offer Rate (Hibor), a daily benchmark for offshore renminbi interbank lending, jumped to 5.446 per cent on Thursday – its highest level since February 19 – from 1.56767 per cent yesterday, write Peter Wells and Hudson Lockett.

Hong Kong banks do not rely on Hibor to anywhere near the same degree that global banks rely on Libor, the more famous US-dollar counterpart that is a crucial benchmark for loans that global lenders rely on for trillions of dollars of funding each day.

As such, the spike in CNH-Hibor has little practical impact on the banks themselves, but it has recently been viewed as more of a deterrent to speculators betting on CNH, the offshore renminbi.

On January 12, CNH-Hibor hit 66.815 per cent, the highest level since the benchmark was introduced in 2013, amid heavy speculation the People’s Bank of China, acting through state-owned banks, was soaking up liquidity to make the cost of shorting the renminbi more prohibitive as the currency came under pressure from speculators.

Ahead of this month’s G20 summit Commerzbank analyst Hao Zhou was among those predicting the PBoC would hold the line at Rmb6.7 against the dollar for a number of reasons, including a desire to facilitate special drawing rights (SDR) operations set to begin on October 1. However, he noted that “of course, politics tops the agenda again, especially as China is keen to show its ability to manage the whole economy and financial markets although the country still faces strong capital outflows.”

The central bank today weakened the currency’s midpoint fix for the first time since the end of G20, a move in line with analyst predictions that efforts to shore up the renminbi’s value would dissipate when the summit was over.

A spike in Hibor would track with a scenario in which the central bank either intervened itself or had mainland banks sop up liquidity on its behalf. It also has other options – as Commerzbank’s Zhou noted late last month: “We also expect that China’s central bank will allow the local banks to trade CNH in September, in order to narrow the CNY-CNH spread.”

This happens after China and the US over the weekend agreed to “refrain from competitive devaluations and not target exchange rates for competitive purposes”.

As my loyal readers know I am very critical about this deal (see my post on that topic here) as I believe that it is an attempt to quasi fix global exchange rates to avoid ‘currency war’ effectively limits the possibility for monetary easing – both in the US and China.

Ending China’s crawling devaluation will be bad news 

Since the Federal Reserve in December hiked the fed funds target rate the People Bank of China effective has tried to decouple Chinese monetary policy from US monetary policy by allowing a crawling devaluation of the Renminbi.

rmb-crawling-devaluation

This in my view has played a positive role in offsetting the negative impact of the Fed’s foolish attempt to tighten US monetary conditions.

However, the Sino-US ‘currency peace’ deal limits the PBoC’s possibility of continuing this policy and this is why HIBOR rates are now surging. This obviously is bad news for the Chinese economy – in fact it is bad news for the global economy and markets.

China does not need tighter monetary conditions. Chinese monetary conditions in my view is still quasi-deflationary and if the PBoC abandons its unannounced crawling devaluation policy it will cause a excessive tightening of Chinese monetary conditions, which could push back the Chinese economy towards recession.

It is too bad that policy makers from the ‘Global Monetary Superpowers’ believe that limiting currency flexibility is the right policy. Instead they should embrace floating exchange rates and instead focus on avoiding the biggest risk to the global economy – deflation.

 

 

In a deflationary world at the ZLB we need ‘competitive devaluations’

Sunday we got some bad news, which many wrongly will see as good news – this is from Reuters:

China and the United States on Sunday committed anew to refrain from competitive currency devaluations, and China said it would continue an orderly transition to a market-oriented exchange rate for the yuan CNY=CFXS.

…Both countries said they would “refrain from competitive devaluations and not target exchange rates for competitive purposes”, the fact sheet said.

Meanwhile, China would “continue an orderly transition to a market-determined exchange rate, enhancing two-way flexibility. China stresses that there is no basis for a sustained depreciation of the RMB (yuan). Both sides recognize the importance of clear policy communication.”

There is really nothing to celebrate here. The fact is that in a world where the largest and most important central banks in the world – including the Federal Reserve – continue to undershoot their inflation targets and where deflation remains a real threat any attempt – including using the exchange rate channel – to increase inflation expectations should be welcomed.

This of course is particularly important in a world where the ‘natural interest rate’ likely is quite close to zero and where policy rates are stuck very close to the Zero Lower Bound (ZLB). In such a world the exchange rate can be a highly useful instrument to curb deflationary pressures – as forcefully argued by for example Lars E. O. Svensson and Bennett McCallum.

In fact by agreeing not to use the exchange rate as a channel for easing monetary conditions the two most important ‘monetary superpowers’ in the world are sending a signal to the world that they are in fact not fully committed to fight deflationary pressures. That certainly is bad news – particularly because especially the Fed seems bewildered about conducting monetary policy in the present environment.

Furthermore, I am concerned that the Japanese government is in on this deal – at least indirectly – and that is why the Bank of Japan over the last couple of quarters seems to have allowed the yen to get significantly stronger, which effective has undermined BoJ chief Kuroda’s effort to hit BoJ’s 2% inflation target.

A couple of months ago we also got a very strong signal from ECB chief Mario Draghi that “competitive devaluations” should be avoided. Therefore there seems to be a broad consensus among the ‘Global Monetary Superpowers’ that currency fluctuation should be limited and that the exchange rate channel should not be used to fight devaluation pressures.

This in my view is extremely ill-advised and in this regard it should be noted that monetary easing if it leads to a weakening of the currency is not a beggar-thy-neighbour policy as it often wrongly is argued (see my arguments about this here).

Rather it could be a very effective way of increase inflationary expectations and that is exactly what we need now in a situation where central banks are struggling to figure out how to conduct monetary policy when interest rates are close the ZLB.

See some of my earlier posts on ‘currency war’/’competitive devaluations’ here:

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

‘The Myth of Currency War’

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

The New York Times joins the ‘currency war worriers’ – that is a mistake

The exchange rate fallacy: Currency war or a race to save the global economy?

Is monetary easing (devaluation) a hostile act?

Fiscal devaluation – a terrible idea that will never work

Mises was clueless about the effects of devaluation

Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons

The luck of the ‘Scandies’

 

The Christensen Media Blitz on the euro, ‘Open Borders’, China and ‘currency war’

I have been in a bit of media blitz recently. Here is some of it:

I have been on Russia Today’s Boom-Bust show to talk to Ameera David about the euro and why I think the euro is a Monetary Strangulation Mechanism. Watch here (after 3:35).

And while we are talking about the euro here is an op-ed of mine from the Danish newspaper Jyllandsposten on the same topic (in Danish).

Then something completely different – here I am telling Berlingske Business the story of my Great-great grandfather Sven Persson who emigrated to Denmark from Sweden in 1880 and hence contributed to the economic development in both countries. I make the case for completely Open Borders and argues that that we could double global GDP if we removed all anti-immigration regulation globally. See my ‘video blog’ here (also in Danish).

Here is an op-ed from the Danish Business Daily Børsen on the Chinese on the Chinese devaluations and why the talk of ‘currency war’ mostly is nonsense.

Finally here is an interview (in French) with Atlantico.fr about the risk of a repeat of the 1997 Asian crisis, My answer is yes, the Chinese situation is worrying, but the good news is that we have floating exchange rates across Asia rather than fixed exchange rates.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Soon everybody will be scared about ‘currency war’ again – we should be celebrating

With the dollar continuing to strengthen and now the Japanese yen starting to take off as well central bankers in the US and Japan are likely increasingly becoming worried about the deflationary tendencies of stronger currencies and recent comments from both countries’ central banks indicate that they will not allow their currencies to strengthen dramatically if it where to become deflationary.

This has in recent days caused some to begin to talk about the “risk” of a new global “currency war” where central banks around the world compete to weaken their currencies. Most commentators seem to think this would be horrible, but I would instead argue – as I have often done in recent years – that a global race to ease monetary policy is exactly what we need in a deflationary world.

If we lived in the high-inflation days of the 1970s we should be very worried, but we live in deflationary times so global monetary easing should be welcome and unlike most commentators I believe a global currency war would be a positive sum game.

Over the last couple of years I have written a number of posts on the topic of currency war. The main conclusions are the following:

  1. Currency war is a GREAT THING and is VERY POSITIVE – if indeed we think of it as a global competition to print money. This is what we need in a deflationary world.
  2. As long as we are seeing commodity prices decline and inflation expectations we can’t really say that the currency war is on yet.
  3. Currency war is NOT a zero sum game. It is a positive sum game in a deflationary world.
  4. Don’t think of monetary easing/currency depreciation to primarily work through a “competitiveness channel”, but rather through a boost to domestic demand. Therefore, we are likely to actually see the trade balance WORSEN for countries, which undertakes aggressive monetary easing. The US in 1933 is a good example. So is Argentina in 2001-2 and Japan recently. Sweden versus Denmark since 2008.

I don’t have much time to write more on the topic this morning, but I am sure I will return to the topic soon again. Until then have a look at my previous posts on the topic (and related topics):

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

‘The Myth of Currency War’

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

The New York Times joins the ‘currency war worriers’ – that is a mistake

The exchange rate fallacy: Currency war or a race to save the global economy?

Is monetary easing (devaluation) a hostile act?

Fiscal devaluation – a terrible idea that will never work

Mises was clueless about the effects of devaluation

Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons

The luck of the ‘Scandies’

The PBoC’s monetary supremacy over Brazil (but don’t blame the Chinese)

Brazilian Finance Minister Guido Mantega likes to blame the Federal Reserve (and the US in general) for most evils in the Brazilian economy and he has claimed that the fed has waged a ‘currency war’ on Emerging Market nations.

As my loyal readers know I think that it makes very little sense to talk about a currency war and  I strongly believe that any nation with free floating exchange rates is in full control of monetary conditions in the country and hence of both the price level and nominal GDP. However, here the key is a freely floating exchange rate. Hence, a country with a fixed exchange rate – like Hong Kong or Denmark – will “import” the monetary policy from the country its currency is pegged to – the case of Hong Kong to the US and in the case of Denmark to the euro zone.

In reality few countries in the world have fully freely floating exchange rates. Hence, as I argued in my previous post on Turkey many – if not most – central banks suffers from fear-of-floating. This means that these central banks effectively will at least to some extent let other central banks determine their monetary policy.

So to some extent Mantega is right – the fed does in fact have a great impact on the monetary conditions in most countries in the world, but this is because that the national central banks refuse to let their currencies float completely freely. There is a trade off between control of the currency and monetary sovereignty. You cannot have both – at least not with free capital movement.

From Chinese M1 to Brazilian NGDP  

Guido Mantega’s focus on the Federal Reserve might, however, be wrong. He should instead focus on another central bank – the People Bank of China (PBoC). By a bit of a coincidence I discovered the following relationship – shown in the graph below.

China M3 Brazil NGDP

What is the graph telling us? Well, it looks like the growth of the Chinese money supply (M1) has caused the growth of Brazilian nominal GDP – at least since 2000.

This might of course be a completely spurious correlation, but bare with me for a while. I think I am on to something here.

Obviously we should more or less expect this relationship if the Brazilian central bank had been pegging the Brazilian real to the Chinese renminbi, but we of course all know that that has not been the case.

The Chinese-Brazilian monetary transmission mechanism

So what is the connection between Chinese and Brazilian monetary conditions?

First of all since 2008-9 China has been Brazil’s biggest trading partner. Brazil is primarily exporting commodities to China. This means that easier Chinese monetary policy likely will spur Brazilian exports.

Second, easier Chinese monetary policy will also push up global commodity prices as China is the biggest global consumer of a number of different commodities. With commodity prices going up Brazil’s export to other countries than China will also increase.

Therefore, as Chinese monetary easing will be a main determinant of Brazilian exports we should expect the Brazilian real to strengthen. However, if the Brazilian central bank (and government) has a fear-of-floating the real will not be allowed to strengthen nearly as much as would have been the case under a completely freely floating exchange rate regime.Therefore, effectively the Brazilian central bank will at least partly import changes in monetary conditions from China.

As a result the Brazilian authorities has – knowingly or unknowingly – left its monetary sovereignty to the People’s Bank of China. The guy in control of Brazil’s monetary conditions is not Ben Bernanke, but PBoC governor Zhou Xiaochuan, but don’t blame him. It is not his fault. It is the result of the Brazilian authorities’ fear-of-floating.

The latest example – a 50bp rate hike

Recently the tightening of Chinese monetary conditions has been in the headlines in the global media. Therefore, if my hypothesis about the Chinese-Brazlian monetary transmission is right then tighter Chinese monetary conditions should trigger Brazilian monetary tightening. This of course is exactly what we are now seeing. The latest example we got on Wednesday when the Brazilian central bank hiked its key policy rates – the SELIC rate – by 50bp to 8.50%.

Hence, the Brazilian central bank is doing exactly the opposite than one should have expected. Shouldn’t a central bank ease rather than tighten monetary policy when the country’s main trading partner is seeing growth slowing significantly? Why import monetary tightening in a situation where export prices are declining and market growth is slowing? Because of the fear-of-floating.

Yes, Brazilian inflation has increased significantly if you look at consumer prices, but this is primarily a result of higher import prices (and other supply side factors) due to a weaker currency rather than stronger aggregate demand. In fact it is pretty clear that aggregate demand (and NGDP) growth is slowing significantly. The central bank is hence reacting to a negative supply shock (higher import prices) and ignoring the negative demand shock.

Obviously, it is deeply problematic that the Brazilian authorities effectively have given up monetary sovereignty to the PBoC – and it is very clear that macroeconomic volatility is much higher as a result. The solution is obviously for the Brazilian authorities to get over the fear-of-floating and allowing the Brazilian real to float much more freely in the same way has for example the Reserve Bank of Australia is doing.

The Kuroda recovery will be about domestic demand and not about exports

There has been a lot of focus on the fact that USD/JPY has now broken above 100 and that the slide in the yen is going to have a positive impact on Japanese exports. In fact it seems like most commentators and economists think that the easing of monetary policy we have seen in Japan is about the exchange rate and the impact on Japanese “competitiveness”. I think this focus is completely wrong.

While I strongly believe that the policies being undertaken by the Bank of Japan at the moment is likely to significantly boost Japanese nominal GDP growth – and likely also real GDP in the near-term – I doubt that the main contribution to growth will come from exports. Instead I believe that we are likely to see is a boost to domestic demand and that will be the main driver of growth. Yes, we are likely to see an improvement in Japanese export growth, but it is not really the most important channel for how monetary easing works.

The weaker yen is an indicator of monetary easing – but not the main driver of growth

I think that the way we should think about the weaker yen is as a indicator for monetary easing. Hence, when we seeing the yen weakeN, Japanese stock markets rallying and inflation expectations rise at the same time then it is pretty safe to assume that monetary conditions are indeed becoming easier. Of course the first we can conclude is that this shows that there is no “liquidity trap”. The central bank can always ease monetary policy – also when interest rates are zero or close to zero. The Bank of Japan is proving that at the moment.

Two things are happening at the moment in the Japan. One, the money base is increasing dramatically. Second and maybe more important money-velocity is picking up significantly.

Velocity is of course picking up because money demand in Japan is dropping as a consequence of households, companies and institutional investors expect the value of the cash they are holding to decline as inflation is likely to pick up. The drop in the yen is a very good indicator of that.

And what do you do when you reduce the demand for money? Well, you spend it, you invest it. This is likely to be what will have happen in Japan in the coming months and quarters – private consumption growth will pick-up, business investments will go up, construction activity will accelerate. So it is no wonder that equity analysts feel more optimistic about Japanese companies’ earnings.

Hence, the Bank of Japan (and the rest of us) should celebrate the sharp drop in the yen as it is an indicator of a sharp increase in money-velocity and not because it is helping Japanese “competitiveness”.

The focus on competitiveness is completely misplaced

I have in numerous earlier posts argued that when a country is going through a “devaluation” as a consequence of monetary easing the important thing is not competitiveness, but the impact on domestic demand.

I have for example earlier demonstrated that Swedish growth outpaced Danish growth in 2009-10 not because the Swedish krona depreciated strongly against the Danish krone (which is pegged to the euro), but because the Swedish Riksbank was able to ease monetary policy, while the Danish central bank effectively tightened monetary conditions due to the Danish fixed exchange rate policy. As a consequence domestic demand did much better in Sweden in 2009-10 than in Denmark, while – surprise, surprise – Swedish and Danish exports more or less grew at the same pace in 2009-10 (See graphs below).

Similarly I have earlier shown that when Argentina gave up its currency board regime in 2002 the major boost to growth did not primarly come from exports, but rather from domestic demand. Let me repeat a quote from Mark Weisbrot’s and Luis Sandoval’s 2007-paper on “Argentina’s economic recovery”:

“However, relatively little of Argentina’s growth over the last five years (2002-2007) is a result of exports or of the favorable prices of Argentina’s exports on world markets. This must be emphasized because the contrary is widely believed, and this mistaken assumption has often been used to dismiss the success or importance of the recovery, or to cast it as an unsustainable “commodity export boom…

During this period (The first six months following the devaluation in 2002) exports grew at a 6.7 percent annual rate and accounted for 71.3 percent of GDP growth. Imports dropped by more than 28 percent and therefore accounted for 167.8 percent of GDP growth during this period. Thus net exports (exports minus imports) accounted for 239.1 percent of GDP growth during the first six months of the recovery. This was countered mainly by declining consumption, with private consumption falling at a 5.0 percent annual rate.

But exports did not play a major role in the rest of the recovery after the first six months. The next phase of the recovery, from the third quarter of 2002 to the second quarter of 2004, was driven by private consumption and investment, with investment growing at a 41.1 percent annual rate during this period. Growth during the third phase of the recovery – the three years ending with the second half of this year – was also driven mainly by private consumption and investment… However, in this phase exports did contribute more than in the previous period, accounting for about 16.2 percent of growth; although imports grew faster, resulting in a negative contribution for net exports. Over the entire recovery through the first half of this year, exports accounted for about 13.6 percent of economic growth, and net exports (exports minus imports) contributed a negative 10.9 percent.

The economy reached its pre-recession level of real GDP in the first quarter of 2005. As of the second quarter this year, GDP was 20.8 percent higher than this previous peak. Since the beginning of the recovery, real (inflation-adjusted) GDP has grown by 50.9 percent, averaging 8.2 percent annually. All this is worth noting partly because Argentina’s rapid expansion is still sometimes dismissed as little more than a rebound from a deep recession.

…the fastest growing sectors of the economy were construction, which increased by 162.7 percent during the recovery; transport, storage and communications (73.4 percent); manufacturing (64.4 percent); and wholesale and retail trade and repair services (62.7 percent).

The impact of this rapid and sustained growth can be seen in the labor market and in household poverty rates… Unemployment fell from 21.5 percent in the first half of 2002 to 9.6 percent for the first half of 2007. The employment-to-population ratio rose from 32.8 percent to 43.4 percent during the same period. And the household poverty rate fell from 41.4 percent in the first half of 2002 to 16.3 percent in the first half of 2007. These are very large changes in unemployment, employment, and poverty rates.”

And if we want to go further back in history we can look at what happened in the US after FDR gave up the gold standard in 1933. Here the story was the same – it was domestic demand and not net exports which was the driver of the sharp recovery in growth during 1933.

These examples in my view clearly shows that the focus on the “competitiveness channel” is completely misplaced and the ongoing pick-up in Japanese growth is likely to be mostly about domestic demand rather than about exports.

Finally if anybody still worry about “currency war” they might want to rethink how they see the impact of monetary easing. When the Bank of Japan is easing monetary policy it is likely to have a much bigger positive impact on domestic demand than on Japanese exports. In fact I would not be surprised if the Japanese trade balance will worsen as a consequence of Kuroda’s heroic efforts to get Japan out of the deflationary trap.

HT Jonathan Cast

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PS Scott Sumner also comments on Japan.

PPS An important non-competitiveness impact of the weaker yen is that it is telling consumers and investors that inflation is likely to increase. Again the important thing is the signal about monetary policy, which is rather more important than the impact on competitiveness.

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

I stole this from Scott Sumner:

Sen. Tom Coburn (R., Okla.) asks whether all the major central banks easing might diminish the benefits and lead to trade protectionism.

“We don’t view monetary policy aimed at domestic goals a currency war,” [Bernanke] says. Easing policy can be “mutually beneficial” to other countries such as China, which depends on domestic demand in the U.S.

It’s a “positive-sum game, not a zero-sum game,” Bernanke says.

I don’t think Bernanke is reading this blog, but I feel like quoting myself:

Monetary easing is not a negative or a zero sum game. In a quasi-deflationary world monetary easing is a positive sum game.

I have not always been impressed with Bernanke and he has certainly made his fair share of mistakes, but he certainly is more knowledgable about monetary policy than Republican lawmakers.

 

‘The Myth of Currency War’

I know that most of my readers must be sick and tired of reading about my view on ‘currency war’. Unfortunately I have more for you. My colleague Jens Pedersen and I have written an article for the Danish business daily Børsen. The piece was published in today’s edition of Børsen. It is in Danish, but you can find an English translation of the article here.

Regular readers of this blog will not be surprised by the main message in the article: The talk of a “dangerous” ‘currency war’ is just silly. It is not really a ‘currency war’, but rather global monetary easing. Global monetary easing even helps the euro zone despite the ECB’s extreme reluctance to ease monetary policy.

Jens has recently also written an extremely interesting paper on the consequence of the ‘currency war’ for the Danish economy. Jens concludes that the currency war – or rather global monetary easing – is good news for Danish exporters despite the fact that the Danish krone has been strengthening in line with the euro (remember the krone is pegged to the euro). The reason is that global monetary easing is boosting global growth and that is outweighing any negative impact on exports from the strengthening of the krone.

Take a look at Jens’ paper here.

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

It is said that Europe is the biggest “victim” in what is said to be an international ‘currency war’ (it is really no war at all, but global monetary easing) as the euro has strengthened significantly on the back of the Federal Reserve and Bank of Japan having stepped up monetary easing.

However, the euro zone is no victim – to claim so is to reason from a price change as Scott Sumner would say. The price here of course is the euro exchange rate. The ‘currency war worriers’ claim that the strengthening is a disaster for European exports. What they of course forget is to ask is why the euro has strengthened.

The euro is stronger not because of monetary tightening in the euro zone, but because of monetary easing everywhere else. Easier monetary policies in the US and Japan obviously boost domestic demand in those countries and with it also imports. Higher American and Japanese import growth is certainly good news for European exports and that likely is much more important than the lose of “competitiveness” resulting from the stronger euro.

But have a look at European exporters think. The graph below is the Purchasing Managers Index (PMI) for euro zone new export orders. The graph is clear – optimism is spiking! The boost from improved Japanese and American growth prospects is clearly what is on the mind of European exporters rather than the strong euro.

PMIexport euro zone

The New York Times joins the ‘currency war worriers’ – that is a mistake

It is very frustrating to follow the ongoing discussion of ‘currency war’. Unfortunately the prevailing view is that the world is heading for a ‘currency war’ in the form of ‘competitive devaluations’ that will only lead to misery for everybody. I have again, again and again stressed that when large parts of the world is caught in a low-growth quasi-deflationary trap then a competition to print more money is exactly what the world needs. ‘Currency war’ is a complete misnomer. What we are talking about is global monetary easing.

Now the New York Times has joined the discussion with a pretty horrible editorial on ‘currency war’.

This is from the editorial:

If all countries were to competitively devalue their currencies, the result would be a downward spiral that would benefit no one, but could lead to high inflation. Certainly in Europe, altering exchange rates is not the answer; reviving economies will require giving up on austerity, which is choking demand and investment.

It is just frustrating to hear this argument again and again. Monetary easing is not a negative or a zero sum game. In a quasi-deflationary world monetary easing is a positive sum game. The New York Times claims that “competitive devaluations” will lead to increased inflation.

Well, lets start with stating the fact a that the New York Times seems to miss – both the Bretton Woods and the gold standard are dead. We – luckily – live in a world of (mostly) freely floating exchange rates. Hence, nobody is “devaluing” their currencies. What is happening is that some currencies like the Japanese yen are depreciating on the back of monetary easing. The New York Times – and French president Hollande and Bundesbank chief Weidmann for that matter – also fails to notice that the yen is depreciating because the Bank of Japan is implementing the exact same monetary target as the ECB has – a 2% inflation target. After 15 years of failure the BoJ is finally trying to get Japan out of a low-growth deflationary trap. How that can be a hostile act is impossible for me to comprehend.

Second, the New York Times obviously got it right that if we have an international “competition” to print more money then inflation will increase. But isn’t that exactly what we want in a quasi-deflationary world? Can we really blame the BoJ for printing more money after 15 years of deflation? Can we blame the Fed for doing the same thing when US unemployment is running at nearly 8% and there are no real inflationary pressures in the US economy? On the other hand we should blame the ECB for not doing the same thing with the euro zone economy moving closer and closer to deflation and with unemployment in Europe continuing to rise.

When the New York Times joins the “currency war worriers” then the newspaper effectively is arguing in favour of a return to internationally managed exchange rates – either in the form of a gold standard or a Bretton Woods style system. Both systems ended in disaster.

The best international monetary system remains a system where countries are free to pursue their own domestic monetary objectives. Where every country is free to succeed or fail. A system of internationally coordinated monetary policy is doomed to fail and end in disaster as was the case with both the gold standard and Bretton Woods – not to mentioned the ill-faited attempts to coordinate monetary policy through the Plaza and Louvre Accords.

The New York Times and other ‘currency war worriers’ seem to think that if countries are free to pursue their own domestic monetary policy objectives then it will not only lead to ‘currency war’, but also to ‘trade war’. Trade war obviously would be disastrous. However, the experiences from the 1930s clearly show that those countries that remained committed to international monetary policy coordination in the form of staying on the gold standard suffered the biggest output lose  and the biggest rise in unemployment. But more importantly these countries were also much more likely to implement protectionist measures – that is the clear conclusion from research conducted by for example Barry Eichengreen and Douglas Irwin.

‘Currency war’ is what we need to get the global economy out of the crisis and monetary easing is much preferable to the populist alternative – protectionism and ‘deflationism’.

HT William Bruce.

Update: It seems like Paul Krugman – who of course blogs at the New York Times – disagrees with the editors of the New York Times.

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