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The term “currency wars” is a catchy way of saying“competitive devaluation.” In the wake of the sharp fall in the value of theyen over the last six months, owing to the monetary component of Japan’sefforts to jump-startits economy, the issue is expected to feature prominently on the agenda at the G-8’s upcoming summit inNorthern Ireland. But should it?
According to the InternationalMonetary Fund, competitive devaluation occurs when countries are“manipulating exchange rates…to gain an unfair competitive advantage over othermembers…” But a key point is often missed when the term “currency wars” hasbeen applied to monetary expansion by the Federal Reserve, the Bank of Japan,and other central banks in recent years. The impact of monetary stimulus on acountry’s trade balance – and hence on demand for trading partners’ goods – isambiguous: theexpenditure-switching effect when the exchange rate responds is counteracted bythe expenditure-increasingeffect of expansion. Restored income growth means more imports fromother countries.
“Currency wars” is a more apt description whencountries intervene to push down their currencies in deliberate attempts tohelp their trade balances. But national authorities will and should pursueeconomic policies that are primarily in their own countries’ interests. Internationalcooperation can be fruitful; but there is little point attempting it if thenature of the spillover effects is not relatively clear to all. Everyoneagrees, for example, that spillovers from pollution or tariffs are negative,not positive, externalities. But the case is not as obvious in the case ofmonetary policy.
For example, ifunemployment is high and inflation low in the United States, the Fed willnaturally ease monetary policy, particularly via low interest rates. If Brazilis in danger of overheating, its central bank will naturally tighten policy,particularly via high interest rates. It is also natural that capital will flowfrom north to south as a result, causing the Brazilian real to appreciateagainst the dollar. That is the beauty of floating exchange rates: bothcountries can choose their own appropriate policies.
Given that the twocountries’ are in different cyclical positions, such exchange-rate movementssignal that the international economic system is working properly. Although thestronger real will help US exporters (other things being equal) and hurt thosein Brazil, such “casualties of war” are not even collateral damage; rather, they are precisely the point.If the goal is to stimulate demand for US goods and dampen demand for Braziliangoods, why shouldn’t exporters in both countries share in that process,alongside construction and other sectors that are sensitive to interest ratesvia domestic demand?
A more seriousdilemma arises if one of the countries is targeting or even fixing the exchangerate, as many Latin American governments did to kill off high inflation in thelate 1980’s and early 1990’s. Such a country will not necessarily want toabandon a proven exchange-rate regime at the first sign of trouble. Capitalcontrols and sterilization of reserve flows might help to delay the adjustment,but a persistent one-directional capital flow will eventually force the fixed-exchange-ratecountry to allow either its exchange rate or its money supply to adjust.
True, in recentyears, a wide array of countries has indicated a preference for weakercurrencies as a means of improving their trade balances. It is also true, bydefinition, that not everyone can depreciate or improve their trade balance atthe same time. But that does not necessarily mean that depreciators are guiltyof violating any agreements or norms, especially if they have merely maintaineda pre-existing exchange-rate regime.
Uncoordinatedmonetary expansion does not even necessarily leave the world in a worseequilibrium. BarryEichengreen and JeffreySachs have persuasively argued this for the 1930’s (the opposite of theconventional wisdom regarding beggar-thy-neighbor competitive devaluations). Although allcountries could not improve their trade balances simultaneously, when theydevalued against gold, they succeeded in raising the price of gold, therebyincreasing the real value of the global money supply – exactly what a world indepression needed.
The same applies today. Brazil’s financeminister, GuidoMantega, coined the term “currency wars” in response to American efforts toenlist Brazil andother competitors of China in a campaign for a stronger renminbi. But theaccusation against the US is especially misplaced. US monetary expansion contributed toglobal monetary expansion at a time when, on average, it was needed. USauthorities have not intervened in the foreign-exchange market or talked down the dollar,and currency depreciation was not the Fed’s goal when deciding to implement itsquantitative-easing policy.
Japan comes a littlecloser to qualifying as a currency warrior, because members of Shinzo Abe’sgovernment were initially foolish enough to mention yen depreciation as anexplicit goal.
China qualifies inone important respect: the renminbi was substantially undervalued by mostmeasures from 2004 to 2009 (less so now).But countries have a right to opt for fixed exchange rates. Continuing anexisting regime, as China was doing, does not sound very much like “manipulation.”
True, renminbiappreciation was probably in China’s interest. It would have been reasonable, beginning in 2004, for those worried about current-accountimbalances to propose that China voluntarily allow some appreciation inexchange for, say, the US putting its fiscal house in order. But this isdifferent from accusing Beijing of violating international norms or rules andthreatening retaliation (for example, by imposing tariffs, which is a violation ofinternational rules).
Few countries accusedof participating in a currency war have undertaken discrete devaluations in recent years oracted to weaken their currencies by switching their exchange-rate regimes.These are the sorts of deliberate policy changes connoted by a term like “manipulation.”Switzerland perhaps comes the closest. But the franc was so strong, even at thenew rate set in September 2011, that no one can accuse the Swiss National Bankof unfair undervaluation.
The world has enoughserious disputes as it is. We do not need to invent new ones
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