Japan, the Race to the Bottom and Central Bank Powers
Japan’s recent all out declaration of war against deflation has many wondering why more central banks aren’t engaging in such policies. After all, the Yen has declined by 20% in a matter of months mainly due to this intervention and the Nikkei is up 33% over the same period. It’s a powerful sign that a central bank can impose its will over the economy if it wants to.
So why don’t more countries just do this, boost inflation expectations and drive the currency down in a manner that is certain to make them more competitive? Simple – the race to the bottom can’t be won by everyone. The simple reality of the race to the bottom is that foreign exchange markets are two-sided. Everyone can’t devalue their currency just like everyone can’t run a trade surplus.
So what would happen if the Fed, ECB and BOJ all declared war on their currencies? What then? That’s not pushing on a string. It’s pushing against a brick wall. Every central bank can’t implement the same policy expecting the same results. Of course, it’s lovely that Japan is having some success with this approach, but it would be foolish to declare this as some sort of sweeping victory for monetary policy around the world. This works in a more micro sense, but it cannot work in an aggregate sense. And as we tend to see with monetary policy gimmicks like currency intervention and “wealth effects” the impacts tend to be fleeting, consistent with short-term disequilibrium and not due to fundamental changes in the underlying economy….
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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12 Comments
Looking at the iShares Nikkei etf in Euro terms you see just how much this rally is driven by the devaluation of the yen. Nikkei up just about 6% since mid Oktober in Euro.
Cullen, 1st sentence, did you mean to write:
“Japan’s recent all out declaration of war against inflation”
It seems like it declaring “war on its currency” as you state elsewhere, and inflation is its tool.
I’d call it more a war against deflation.
OK, but you agree something’s wrong with that 1st sentence? Like it’s the opposite of what he meant to write?
War against deflation. Thanks.
Isn’t the “Golden Fetters” argument, that due to the gold standard, countries were unable to accommodate the fall in demand and investment with monetary and fiscal policy. Once they became unfettered from gold, they were able to reflate and provide demand, and that eased the pain. Relative gains in trade competitiveness tended to be smaller as each country eventually worked through this process. There were short-term relative gains for early movers. Unable to reflate, countries were quicker to turn to protectionist trade measures.
Even though nobody can gain a relative edge through currency wars today if everyone is at war, it would have the effect of increasing reflationary pressures from monetary and fiscal policy. Eventually, this could morph into more capital and trade controls, which would be negative.
By the way, reflation in asset values without inflation in incomes is simply an asset bubble. See the Grantham note that Cullen referenced earlier. But, that is an issue for another day!
Currency wars are a 20 century affair. They are pointless now. The race to the bottom will not be won by whoever devalues first, but whoever automates first. You can not beat productivity through automation with productivity through weaker currency in 21 century. It does not matter how weak your currency is, if you still have to pay a human worker’s wage you won’t be able to sell your product cheaper than if production is fully automated. And on top of that your product most likely will be of higher quality if produced by a machine. The problem to fear is the race to the bottom through automation because if we do not figure out how to substitute the lost aggregate demand due to increased unemployment because of automation, then we all are in trouble.
Hi Cullen,
Ignoring for a minute some of the restrictions in their ability to do so, wouldn’t an exception to your statement be if all central banks dropped the value of their currency at the same time, by the same amount.
For example, let’s say all central banks halved the value of their currency at the same time. This wouldn’t give any one country a trade advantage, but it would have the effect of halving the burden of debt.
I realize this is a simplistic description and there are technical challenges, but would enjoy your thoughts on the broader concept.
I see that as the end game here. The central banks are working together.
You have to look at what is the likely desired outcome.
Japan has suffered a strong yen hitting it’s export earnings and is now counteracting that given that trade deficits have arisen.
However if everyone does it, then there is no competitive advantage. And everyone is doing it just not in step [and the euro arguably not at all].
The end result is inflating away income values and importantly debt – which afflicts all of the west.
Of course there is a final step and that is the distribution of money into the general economy to finally devalue those debts in nominal terms. Incomes have to rise – currently that’s only happening higher up the food chain.
Currently the powers that be are hoping that blowing bubbles will do that through our oh so efficient private [banking] sector.
I’d suggest that the wealthy and powerful are quite liking this bubble blowing as it’s a great way to make money quickly.
Note Iceland called the bankers’ bluff, arrested some, the economy nose dived, asset values crashed. They are now growing at over 2%/year and banks will never again get the power to do what they want over there.
Who is your government really working for?
How much does the recent yen weakness have to do with the shift from trade surpluses to trade deficits? If I remember correctly this shift occurred before Abe’s policy stance was known.
“This works in a more micro sense, but it cannot work in an aggregate sense. And as we tend to see with monetary policy gimmicks like currency intervention and “wealth effects” the impacts tend to be fleeting, consistent with short-term disequilibrium and not due to fundamental changes in the underlying economy….”
Cullen’s ending paragraph, I assume, alludes to Japan’s quirky banking system and even demographic phenomena (among others). Those are currently the most notable components of their national economic and social system, in my mind, and I’d enjoy anyone else’s comments on how they can be strengthened for longer-term benefit.
Good piece, Cullen. Gets you thinking.