Statement of G20 Finance Ministers and Central Bank Chiefs Comments Favorably on Japan

April 21, 2013

On the sidelines of the IMF/World Bank meetings in Washington, financial leaders of the Group of Twenty met April 18-19 and released a statement that gives Japan not even an amber light but rather a green light to pursue its new policy program even if such depresses the yen further.  Using unmodified language, the statement defines currency depreciation that is unacceptable:

We reiterate our commitments to move more rapidly toward more market-determined exchange rate systems and exchange rate flexibility to reflect underlying fundamentals, and avoid persistent exchange rate misalignments. We will refrain from competitive devaluation and will not target our exchange rates for competitive purposes, and we will resist all forms of protectionism and keep our markets open. We reiterate that excess volatility of financial flows and disorderly movements in exchange rates have adverse implications for economic and financial stability. Monetary policy should be directed toward domestic price stability and continuing to support economic recovery according to the respective mandates of central banks. We will be mindful of unintended negative side effects stemming from extended periods of monetary easing.

Motivation is a critical criteria for discerning if a policy action can be call competitive currency depreciation, much more so than if the action causes one’s currency to weaken.  In Japan’s case, the statement explicitly states that “recent policy actions are intended to stop deflation and support domestic demand.”  Period.  Japan has experienced deflation for more than a decade, and gradualist policies have been an ineffective response.  Japanese nominal GDP has contracted and domestic demand has been anemic.  A policy of qualitative and quantitative monetary easing is justified under the G20’s criteria. 

What about the G20’s stated opposition to persistent exchange rate misalignments?  Rather than cast dispersions on the appropriateness of policies that have weakened the yen from the high 70s per dollar to the upper 90s and that could cause further depreciation, the opposition to persistent misalignment in fact supports action to depress the yen, which on objective criteria was overvalued when it hovered near 80 per dollar from October 2010 through November 2012.  An exchange rate ought to capture the present value of an economy.  In 1989, Japan’s Nikkei index of 225 share prices hit a record high of 38,916, and there was an outpouring of financial press hypothesizing when Japan might overtake the U.S. economy, much as more recently has been written about China.  The yen ended 1989 at 143.7 per dollar and would touch 160/USD in the following year.  Japan was running substantial trade surpluses then but now shows chronic deficits.  Comparing conditions and investor expectations about Japan then to those now, the surprise is that the yen should be stronger now than then, let alone hovering near record highs without respite for a period of two years. 

The health of Japan’s economy remains terribly important to the world economy.  Being still the third biggest economy on the planet, robust Japanese domestic demand is a top priority and ought to transcend any misgiving that the monetary policy stimulus of the Abe government and Kuroda Bank of Japan might generate a loss of price competitiveness for Japan’s trading partners vis-a-vis Japanese exports and import-competing goods and services. 

The greater worries, indeed, ought now to be why the new policy is not depressing long-term Japanese interest rates further, why the yen has stayed on the strong side of 100/USD, and why Japanese transactions in stocks and bonds with non-residents generated a 4.35 trillion net capital inflow during the two weeks to April 12.  These developments suggest that in the early going, the policy is not producing its intended impact.  It long-term rates do not drop and the yen doesn’t depreciate further, deflation isn’t going to be beaten, and growth in domestic demand will continue to be unacceptably low.

The G20 has defined bad competitive currency depreciation in a way that renders such non-applicable for the world’s wealthier or developed economies.  Very few have inflation problems, and most have too much unemployment and too little usage of capital stock.  There is a widespread need for some kind of stimulus to demand management, but the G20 statement rules out actions that would make budget deficit spending even greater:  “maintaining fiscal sustainability in advanced economies remains essential.”  Structural reforms are urged, but these do not generally produced quick results.  That leaves monetary policy, which needs to be loose, and a primary channel through which monetary stimulus works is the exchange rate.  It would thus seem that G20 policy on exchange rates as expressed in the italicized excerpt above only has applicability to emerging and developing economies such as China, which runs a chronic current account surplus and where foreign exchange reserves are accumulating.  This is a sign of currency intervention to counter market forces that otherwise would strengthen the yuan more quickly. 

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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