The Race for Weaker Currencies
November 7, 2013
Comparisons to conditions during the Great Depression were made often back in 2008 and 2009, less so for a couple of years thereafter, but are popping up again. One of the notable dissimilarities at first concerned commercial policy in the two periods. Beggar-thy-neighbor tactics were common in the 1930s. Saddled with anemic domestic demand, governments tried to gain trade advantages, and the tactics weren’t limited to tariffs and quotas. Currency manipulation came into play. In Lords of Finance, Liaquat Ahamed observes that governments, which abandoned the gold standard and let their currencies depreciate early, like Britain, generally experienced less severe downturns than those like the United States that delayed that decision until later. The problem is that protectionism is rarely unilateral. Retaliation happens, advantages prove transitory, and suffering is magnified and widely shared by the deterrent to two-way commercial traffic. In counting up the things that governments did right during the Great Recession, a spirit of cooperation and rejection of protectionism was high on the list.
While a stampede into protectionism has been avoided, resistance to that temptation has clearly frayed, and it’s because other policy options have been very limited. Containing dollar strength, if not eking out some depreciation, had to have been an objective of the Fed’s three bouts of quantitative easing. Monetary officials weren’t meeting either mandate — 2% inflation or lower unemployment — despite a zero interest rate policy. The government, whose expenditures fell by 2.2% per year between 3Q10 and 3Q13, has shirked its Keynesian responsibility to supplement aggregate demand if the private sector misfiring. Yen depreciation was a keystone of BOJ Governor Kuroda and Prime Minister Abe’s effort to end deflation. Goosing the monetary base has lifted bank lending only slightly but had a quick and electrifying impact on the yen, whose decline promoted economic growth and raised import prices. After other measures to prevent a mounting risk of deflation proved unsuccessful, Swiss National Bank officials in September 2011 launched a policy to intervene when necessary to prevent the franc from strengthening past 1.2000 per euro, and Czech central bank officials just today hopped on the intervention wagon, vowing to link the kurona to the euro at a parity of 27. Verbal intervention has been employed by Australian and New Zealand officials to push their local currencies lower.
The European Central Bank until now has stood apart with ancestral roots steeped in a philosophy that places the burden of proof on those who would argue that inflation is too low or that price risks are skewed to the downside. As in other economies, other remedies to reduce unemployment, combat financial market fragmentation, and empower members to find a viable path to long-term competitive survival have yielded spotty and mostly disappointing results. The euro is a straitjacket, and in the absence of a big boost to German domestic demand, there’s scant hope for real closure to the region’s debt and growth crisis. A substantial euro decline would greatly help lift inflation back toward the ECB’s target and reduce the unsustainable current account deficits of the bloc’s vulnerable members.
To make a discernible contribution, the euro would need to depreciate far more than now seems reasonable. I submit that a return to the currency’s life-time mean of $1.2173 next year would not do the trick. The euro rather needs to match what happened to the yen. From an average value of 79.81 per dollar in 2012, the yen through the first ten months of 2013 had depreciated 17% on average in adjacent years. Even with that, it’s not assured that the goal of 2.0% CPI inflation there will be secured in a stable way by 2015. Most analysts doubt this will happen, but the extent of yen decline serves as a useful yardstick for what the ECB needs to have happen to return regional inflation to target, to secure sustainable and improving recovery in aggregate demand, and to produce a knock-off beneficial effect on the health of the financial system. A 17% decline of the euro from this year’s mean of $1.3218 implies a 2014 mean of about $1.1000.
That’s not a totally improbable. Year after year, some currency market pundits have predicted that the dollar would advance to par with the euro in the coming year. For the euro to average $1.10 in 2014 in so far as it’s currently a shade stronger than its 2013-to-date mean, it almost certainly will need to spend some time next year hovering at or below $1.0000. This would be an incredible change in the EUR/USD’s behavior from its currently stable form. Consider, for example, that since the start of the second quarter this year, EUR/USD has fluctuated in a high-low range of only 7.3% between $1.3809 and $1.2864, whose midpoint of $1.3337 is close to the current level and to the period mean of $1.3237. The euro does not appear to be in any hurry to return to lows not seen in over a decade.
To make matters worse, relations between key Euroland politicians and the Obama administration have turned a bit frosty over spygate, so the policy cohesion is absent to orchestrate a substantial currency configuration as was done in 1985-87. Blatant protectionism to soften the euro would invite U.S. retaliation, the Achilles heel of beggar-thy-neighbor growth strategies. In the meantime, a return to excessive inflation in the near term should not be a realistic concern. It took over a decade for the era of price stability in the 1950s and early 1960s to transform into the manifest inflation problem that the Federal Reserve addressed seriously in 1979. One can better argue against taking comfort from stable and well-anchored measures of expected inflation that deflation. Long-term interest rates have turned the corner but not inflation. U.S. CPI inflation of 1.2% over the past year is down from 2.0% in the prior 12 months. The latest core personal consumption price deflator, 1.2%, is down from 1.6% a year earlier. Euroland has total and core inflation of 0.7% and 0.8% at present versus 2.5% and 1.5% a year before. Japanese consumer prices excluding volatile food and energy shows a zero on-year pace, which although 0.6 percentage points higher than a year earlier is nonetheless still less than inflation in the U.S. or Euroland. Moreover, unemployment is at a record high of 12.2% in the Ezone. The time has come when the euro ought to weaken significantly, but one has to doubt whether this could or would be allowed to ever happen.
Copyright 2013, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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