Davos: Currency Wars Rage, US Losing
Davos: Currency Wars Rage, US Losing
Friday at Davos US hedge fund manager Ray Dalio noted that talk of purposeful currency devaluation to make up for an economy’s inefficiency, the engine of currency wars is a “conversation that is not polite to have.”
World leaders are now feeling comfortable talking openly of their plans to drive down currency exchange rates.
Italian Prime Minister Matteo Renzi says that his “dream” was parity between the EUR and USD. Italian exports have been growing lately, averaging $37.4-B in the first 11 months of last year, 1.7% higher than in the same frame of Y 2013, but Mr. Renzi hopes more support from the European Central Bank (ECB) can make up for the fact that labor productivity in his country is just 72.8% of the US’.
So now the words “currency war” are part of the mainstream discourse, not just one of Nouriel Roubini’s stock scares.
In Davos, Goldman Sachs President Gary Cohn said that the world has been in a currency war since Japanese Prime Minister Shinzo Abe’s policies started pushing down the Yen’s rate 2 yrs ago. After that, Europeans joined in and started devaluing the EUR.
Now the ball is in Japan’s court again, and the US is “just sitting here watching, being the country whose currency is rallying because everyone else is trying to devalue.” Only recently, Switzerland has joined the US “We are happy to have them on that side of the ledger,” Mr. Cohn said sarcastically.
Economic data broadly bear out Mr. Cohn’s view of the competition dynamics. Japanese exports (shown below in billions of Yen) slumped in Ys 2011 and 2012, then rallied hard since Mr. Abe’s devaluation:
Euroarea exports stagnated as the ECB hesitated to introduce more stimulus:
So far this year, according to the correlation-weighted indices, the USD has gained 2.83% Vs a basket of other developed nation currencies, and the Yen has gained 4.77%. EUR is down 4.88%, and the ECB’s QE program has not started yet. Even the talk of QE has made European exporters much more competitive.
According to the January 2015 edition of The Economist’s Big Mac index, which uses the price of the McDonalds staple in various countries as a measure of purchasing power parity, Euro is already undervalued compared to the Buck, while in July, the index showed that it was overvalued.
That standard isn’t definitive, but it one gives reason to wonder whether the ECB’s plans for additional might be on the over aggressive side. Europe might improve its export competitiveness at the expense of inflation.
In Y 2013, as Abenomics got into full swing, the US Treasury was openly worried about Japan starting a currency war.
“We will,” it said in the April, 2013 edition of its currency rates report to Congress, “continue to press Japan to adhere to the commitments agreed to in the G-7 and G-20, to remain oriented towards meeting respective domestic objectives using domestic instruments and to refrain from competitive devaluation and targeting its exchange rate for competitive purposes.”
Now, as Europe makes its competitive move, the US government appears relaxed.
It is not making any threatening references to gentleman’s agreements among world leaders to prevent currency wars. In the latest edition of that report, which came out last October, the US Treasury raised no Red Flags about any countries that might be devaluing their currencies competitively.
In December, US Treasury Secretary Jack Lew said it was “wrong to get into currency exchange-rate competition” but added: “On the other hand, we have called on many countries in the world to take decisive action to get their economies to grow.”
It is true that, in order to keep growing at its current rapid pace, the US needs a boost in global demand. But its complacency about the scale of planned ECB action may be misguided. If EUR sinks toward parity with USD, European manufacturers will take advantage of US growth, but American manufacturers will become un-competitive in Europe.
Other central banks, those in India and Canada, among others have been cutting rates and weakening their currencies, too.
Mr. Dalio sees the moves leading to a “short squeeze” on USD like the one seen in the 1980s, which required concerted action from central banks to curb the Buck’s rise and prevent the US economy from tanking. Now, however, such action is less likely because countries such as Italy see QE as their chance to restore growth. As it is easier to print money than to raise productivity closer to US marks.
Have a terrific weekend.
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