Currency War: It won´t happen

Kocherlakota writes “Bring On the Currency War”:

The U.S. government seems concerned about what will happen if other big nations push down the value of their currencies against the dollar. Actually, it could be good for the global economy.

Ahead of this week’s meeting of finance ministers from the Group of Seven developed nations, Treasury Secretary Jacob Lew has warned that the U.S.’s counterparts — the three largest euro-area nations plus Canada, Japan and the U.K. — might undermine global growth if they engage in policies that cause their currencies to depreciate against the dollar. In my view, his concerns are misplaced.

That´s an obvious point, just look what happened to the countries that devalued (delinked from gold) in the early 1930s, but:

  1. The US has selectively (and Japan in the 1980s is the “representative” example) over time “warned” countries about letting their currencies depreciate against the dollar.
  2. The US position as a “monetary superpower” indicates that it dictates to a large extent the world´s currency “configuration”.

The charts below show, through some examples, how US monetary policy has ‘shaped’ the broad dollar index over time.

Currency War_1

Whenever US monetary policy is tightened (measured by an enlargement of the NGDP ‘gap’ relative to the “Great Moderation” trend, or a narrowing if coming from above), the dollar appreciates relative to a broad basket of currencies. If US monetary policy is “eased” (measured by the NGDP ‘gap’ narrowing, or enlarging if from above trend), the dollar depreciates.

Now, Japan is in the news. Actually, it´s described as “Elephant in the Room at This Week’s G-7 Is Sure to Be the Yen”:

When finance chiefs and central bankers from the Group of Seven countries gather this week at a hot springs resort in northern Japan, the official agenda has them focusing on ways to revitalize global growth and crack down on cross-border tax evasion.

Left off the discussion list is one of the most pressing concerns for the host nation: how to counter a 10 percent surge in the yen that’s squeezing an economy unable to escape a cycle of expansion and contraction. Cries for sympathy are likely to fall on deaf ears, given the tailwind corporate Japan got in the first years of the Abe administration from the currency’s sharp depreciation.

As the chart indicates, Abenomics was successful from inception because the expansionary monetary policy undertaken by Abe/Kuroda managed to depreciate the Yen by more than the Broad Dollar Index.

Currency War_2

But more recently, while Japan´s monetary policy has faltered, the US has relented on “tightening” (although this seems to have changed as indicated by the Minutes released yesterday). That was a “deadly” combination from Japan´s perspective.

In short, Japan did it to itself! If the US “tightening bias” is resumed and Japanese monetary policy makers rethink their strategy, the Yen will again depreciate. If the FOMC “lightens-up” again, as it did earlier this year, Japan´s monetary policy will have to be even “braver”!

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