Time May Have Come for Currency Wars to Heat Up

December 14, 2012

Finance Minister Montega of Brazil first coined the term “currency war” in September 2010, but the concept of competitive depreciation on a multilateral scale has not become a dominant currency market theme until now.  2013 could be different.  Weak global growth is likely to persist, along with sub-target inflation.  In a policy-constrained environment, the expeditious temptation will mount to boost exports by seeking more competitive exchange rates.  If practiced by many, this opaque form of protectionism risks weakening everyone’s growth prospects.  World leaders recognized this danger early in the Great Recession and have been generally successful thus far refraining from blatant currency warfare.

However, governments are now embarking on policies that are in part intended to cheapen currency values.  Surely, that is one objective of the Fed’s more aggressive quantitative effort to boost job creation.  An election this weekend in Japan is almost certain to bring the Liberal Democratic Party back to power, and a central priority of the LDP economic policy agenda is greater monetary stimulus and not throttling such back until inflation climbs near to 2% and the yen falls.  European officials are counting on a revival of export demand to end the current recession and put a mild recovery in play as mid-2013 approaches.  The Swiss National Bank has for the past fifteen months used intervention to prevent the franc from strengthening beyond 1.20 per euro.  Several commodity-sensitive economies have struggled with the burden of excessive currency strength.

The dollar is ending 2012 near its central tendencies.  With just two weeks remaining in 2012, the buck is trading close to its year-to-date average levels.  In such comparisons, the greenback presently shows losses of 4.5% against the kiwi, 2.2% against the euro and Swiss franc, 1.9% versus sterling, 1.8% against the Canadian dollar, 1.4% relative to the Canadian dollar and 1.1% vis-a-vis the Chinese yuan.  The Japanese yen, in contrast, is 4.7% weaker than its 2012 mean value of 79.60 but was stronger than that level as recently as November 14.  Japan’s verbal saber-rattling on the yen accounts for the reversal of the yen’s momentum recently, but the currency has a long way to go to recover historic competitiveness.  In comparisons of current dollar rate levels to calendar 2006 averages, that is the last complete year before the financial crisis, the dollar still shows net depreciation of 28.2% against the yen versus a drop of just 4.5% against the euro and an advance of 14.2% relative to sterling.  This second comparison also reveals large-sized dollar losses of 28.9% against the Australian dollar, 26.7% versus the Swiss franc, and 13.1% against the loonie.

Now that mid-December is upon us, it will take another month before currency swings can be really trusted to reflect underlying tendencies and not yearend seasonal distortions.  From the earliest day’s of flexible dollar exchange rates set by market forces, a bias revealed itself for the dollar to drop against the German mark in the second half of December.  Between 1974 and 1987, this happened in every year except 1984, and the average dollar loss between December 15 and December 31 from 1973 through 1987 was 1.5%.  This consistent pattern then went cold over the following decade, trimming the average dollar loss in late December to 0.9% for 1973-98.  Interestingly, a loss of 0.9% is also the average size of the dollar’s decline between mid- and end-December against the euro since the common currency was launched in 1999.  From a trading standpoint, the week after Christmas has usually tended to see more activity than the week before the holiday.

Seasonal tendencies in the dollar reverse direction when the calendar year page gets turned.  Since 1999, the dollar on average has risen 0.8% between end-year and January 15, and the average advance against the mark since 1975 has been 1.1% during the first half of January.  In 2012, for example, the dollar rose 2.3% in this period.  In the cusp between 2012 and 2013, the big storyline will be how the U.S. fiscal talks are resolved.  Central banks have spoken this month, and now it’s up to the politicians to become the main market driver.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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