It’s complicated

A James Alexander post

We were rightly excited by John Williams letter from San Francisco on Monday as we had already detected stirrings. We and many others were also equally right to wonder what was going on when JW reverted to type on Thursday.

The JW-induced downward move in the USD Index stuck. The move down was against all major currencies but specifically against the JPY where it fell through Y100 to the USD for a while on Tuesday and more persistently on Thursday.


The Japanese were repeatedly browbeaten by the US Treasury when their currency versus the USD had traded up to Y120. They did what they were told, pulling back from more QE. However, the US Treasury campaign still culminated in the creation of the ignominious “monitoring list” in April this year.

Now the Japanese find themselves with an even stronger currency than in April and overnight we see reported “plunging foreign trade“. In July export volumes were down 2.5% and imports down 4% – despite the new buying power. Exports by value were down 14% and imports by value were down 25%. AD is suffering.

Even more USD weakness to come?

The reaction to the idea of further reform of US monetary policy by John Williams ahead of the “Designing … Frameworks For The Future” brainstorming at Jackson Hole was pretty swift. Japanese currency chief called journalists into his office in Tokyo and issued a public warning.

William Dudley and his market-monitoring colleagues on the NY Fed frontline must have either had a call from Tokyo or felt compelled to react first or both. The NY Fed President’s hastily arranged a five minute interview on CNBC attempted to put a floor on this new USD weakness. Very significantly, he failed. Maybe Dudley failed because he looked so ashen-faced. On such things markets move, or rather refuse to move. John Williams’ latest public speech was very much back-to-business as usual for him, but also failed to raise the USD.

However, the NGDP Level Targeting bandwagon may be hard to stop as widely-read commentators as diverse as Larry Summers and Stephen King both weighed into the debate in favour.

Central banks do not act in isolation from one another. The US monetary tightening since mid-2014 has been causing a global slowdown. The active tightening in December 2015 caused global markets mayhem by early 2016. The rowing back from that tightening caused the USD to weaken, particularly against the JPY.[See chart above]

Ironically, if the US were to adopt NGDP Level Targeting it would lead to a stronger US economy and alleviate the pressure on the currency. The markets do not see it that way at the moment, though.

Most of the world’s central banks have had to pull back from their post-2009 tightening, the Federal Reserve probably will be no different. But it will cause a lot of major ripples, no doubt. Things are complicated. 

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”!

John Taylor “celebrates” 30 years of the Plaza Accord

John Taylor:

That the dollar depreciated across the board—as much against the mark as against the yen—suggests that it was part of a general reversal of the dollar appreciation experienced during 1981-1985 due to the monetary policy strategy the Fed had put in place.  As Alan Greenspan put it in an FOMC meeting in 2000, “There is no evidence, nor does anyone here [in the FOMC] believe that there is any evidence to confirm that sterilized intervention does anything.”

The dates of the Plaza and the Louvre meetings are marked in the chart. Observe how the move toward an excessively restrictive policy starts at the time of the Plaza meeting. Indeed, as chart shows, the Bank of Japan increased its policy rate by a large amount immediately following the Plaza meeting, which was in the opposite direction to what macroeconomic fundamentals of inflation and output were indicating. Then, after a year and a half, starting around the time of the Louvre Accord, Japanese monetary policy swung sharply in the other direction—toward excessive expansion.  The chart is remarkably clear about this move. The policy interest rate swung from being up to 2¼ percentage points too high between the Plaza and the Louvre Accord to being up to 3½ percentage points too low during the period of time from the Louvre Accord to1990.

The highlighted sections denote “rubbish”. The dollar never appreciated relative to the yen in the years before the Plaza. It did so against the German DM. So you cannot say “it was part of a general reversal of the dollar appreciation experienced during 1981-1985…”

And God forbid what would have happened to the Japanese economy if between 1987 and 1990 the BoJ had followed the “Taylor-rule”! As we now know, that was the time that Japanese NGDP flattened out and Japanese real growth all but disappeared!


The fact is that Japan could never let the yen depreciate relative to the dollar. It could and should appreciate! The initial rise in the BoJ´s call rate was to make sure that happened.

Central Bankers and “comfort zones”

This piece in the WSJ caught my eyes: “A Yen Too Weak Even for Japan”:

Japan has been celebrating the fall of the yen for the past two years. The currency is now reaching levels that could make policy makers wonder if they’ve gone too far.

The yen has cruised through 120 to the dollar, nearing the key 125 level that officials in Tokyo have signaled would be a tipping point for concern. Etsuro Honda, a top adviser to Prime Minister Shinzo Abe on economic policy, told The Wall Street Journal in November that if the yen weakens to 125 it would make him “nervous” and make him “stop and think, ‘is this OK?’”


With the yen already near the limits of their comfort zone, Mr. Abe and central bank Gov.Haruhiko Kuroda will find themselves in a difficult position.

Such “shortsightedness”! Look at the Yen/USD since exchange rates since the breakdown of Bretton Woods:

Yen stigma_1

The small “Abenomics upward squiggle” has taken the exchange rate closer to levels that prevailed for several years before the global crisis, when Japan was in “deflation mode”!

The funny thing is that the US has always eyed the yen with great suspicion. During the first half of the 1980s, the dollar appreciated enormously against all currencies except, you guess, relative to the yen. But when the Plaza Accord – an agreement between the governments of France, the US and the UK to depreciate the dollar in relation to the Japanese yen and German Deutsche Mark – was signed in September 1985, the yen appreciated as “agreed”. Notice that the DM only returned to the “starting point”. It appears the object of the exercise was to “clobber Japanese competitiveness”!

Yen stigma_2

Abe & Kuroda should ditch the “yen always has to appreciate” stigma. They´ll find themselves in a difficult position if they start worrying about “comfort zones” for the yen!