26th November 2013 by Shaun Richards
One of the strongest forces in economics is often either ignored or treated as something that cannot be controlled. The Bank of England has regularly chanted Shaggy’s hit “It wasn’t me” when confronted with the consequences of the 2007/08 over 20% fall in the value of the pound sterling on the foreign exchanges. However as central banks around the world run out of policy options (you do not have to believe me on this subject simply watch the number of denials that this has happened as confirmation) we are likely to see ever more join the ranks of those attempting to lower or devalue their exchange rate. It was only on the 11th of this month that I discussed the way that the Czech National Bank had started on its own adventure to lower the value of the Koruna.
The Driving Forces
This can be summed up with two factors. Firstly economic growth is disappointing in many areas highlighted by the way that the OECD reduced its economic growth forecasts by “about half a percentage point” only last week. This had a consequence for another area of their forecasting which if it turns out to be true will put further pressure on central banks.
The jobless rate in OECD countries is projected to fall by only half a percentage point, to 7.4%, by the end of 2015, a slower decline than had been expected.
Secondly more and more countries are finding themselves suffering from disinflationary pressure and those with high debt burdens find this uncomfortable. This is something I analysed only yesterday for the Euro area which is currently facing this issue.
As currencies are valued in terms of other currencies for each one that goes down another must be going up. There is no avoiding this in what is a zero sum game unless of course the answer to David Bowie’s question “Is there life on Mars?” is not only yes but that they have something to trade. This is why Brazilian Finance Minister Guido Mantega talked of “currency wars” back in 2010 as the Real found itself rising and rising against the US Dollar. That phase ended but we have seen new issues rise in 2013.
One possible exception to the zero sum game is that a currency can move against precious metals such as gold. As it rallied in the early phases of the credit crunch pretty much every currency did fall against it. But 2013 has seen paper currencies appreciate against gold as it has fallen from US $1675 to US $1250 per troy ounce. Even the currencies such as the Japanese Yen and the Indian Rupee which have been amongst the weakest in 2013 have appreciated against gold.
For those interested in the old style of mercantilism the pattern for Silver is similar to that of Gold in 2013. So we have seen paper currencies appreciate against precious metals in 2013 which has me wondering what economic effect this may have caused.
Those applying the currency war strategy
In essence the main arrow of Abenomics is to depreciate the Japanese Yen and by that route reinvigorate Japanese industry via the route of price competition. Somewhat sneakily the consequent inflation from this is also a policy aim which will not be welcomed by Japanese consumers and workers. Having started the year at just below 87 Yen to the US Dollar it has fallen to 101 Yen to the US Dollar. It now takes 137 Yen to buy one Euro as opposed to the 114 at the start of 2013 and for the pound the current number is 164 Yen versus the 141 of the new year.
So Japan receives a competitive advantage and boost from a weaker currency. However on the other side of the coin the Euro area gets another push towards disinflation as everything priced in Yen has got a lot cheaper in 2012.
However some care is needed in the treatment of Japan as a currency manipulator as the Yen was driven higher by the carry trade and has so far only returned to the levels of 2009. So if you think of it as jumping into Dr.Who’s TARDIS it has not got far. Although a cheerier thought is that it is back close to the levels where the Euro began in 1999.
We are left with the thought that there are two factors at play here. Firstly there is the level and secondly there is the rate of change of it. Fast moves can lead to economic dislocation even if they are correcting a previous imbalance.
The Rupee has had a ropey 2013 even though the dark days of September when it nearly touched 69 versus the US Dollar have been replaced by a calmer 62.5. Even so this is a nearly 15% drop on where it started the year. This adds to previous falls which suggests that India is something of a serial offender in this area.
But there is a nuance in this in that much of this was outside its control. Whilst the actions of the Reserve Bank of India in February were questionable and risky as I discussed at the time in the article linked too below the currency was also affected by the backwash of the US to taper or not too taper debacle.
It is sobering to consider a nation and economy the size of India’s being a bobbing cork on the ocean of US monetary policy especially as it was a combination of mistakes which caused it. The chapter in economics textbooks on “small open economies” needs some revision to say the least.
The Commodity Currencies
These have been falling in 2013 as commodities prices have dipped. Both the Aussie and Canadian Dollars have been falling as the consequences of being a commodity based asset with a population attached are being digested. If we look at the Aussie Dollar versus the pound it now takes 1.77 to buy a pound as opposed to 1.56 at the start of the year. The problem however for Australia and Canada is that this is outside their control causing a situation which Canadians might well regard as loonie.
These matters have consequences which often come under the category of be careful what you wish for. Those of the Barmy Army who found that the price of following the UK cricket team took a dip may after the result of the first test be wishing that it had not!
Switzerland and the Czech Republic
If we consider the problems of the Euro it is revealing that both Switzerland and the Czech Republic have capped their currencies against it. In something of a theme Switzerland has found that a solution to one problem (a surging Swiss Franc) has turned its national bank into a hedge fund with enormous foreign exchange reserves to invest. It would appear that the Czech National Bank is on the same road albeit on a more minor scale.
The Czech National Bank bought foreign exchange worth about CZK 200 billion in its foreign exchange interventions in the period up to 20 November. According to the ten-day balance sheet, the CNB’s total assets increased to CZK 1,077 billion as of 20 November 2013.
However there is something disturbing in this next bit of their statement.
an effort to avoid the risk of harmful deflation and to maintain price stability.
What they are actually doing is exporting such problems to others. As they are specifying the policy against the Euro then that is where the main effect will be felt.
Who is appreciating then?
There must be currencies rising as others fall. We are losing many of the ones which were rising strongly as either circumstances have changed or they have acted to stop it. Some currencies have risen as the Euro is up 4% in 2013 and the Chinese Yuan is up by 2.4% whilst the pound has risen in recent months however care is needed as it has merely returned to where it began the year. The US Dollar has not moved much either at -1%.
So it seems that a lot of currencies that are not on the main list have risen in 2013.
The situation is fraught with danger right now as any further economic disappointments will push more central banks towards the currency depreciation option. This will happen at a time that it is not so easy to achieve as monetary policy is already loose in so many areas. Accordingly the danger of repeating the mistakes of the competitive devaluations of the 1920s and 30s is rising. Sadly if that happens we be further on our way to repeating pretty much the full set of mistakes from that era.
Underlying all this is a very difficult question which seems simple. What is the right exchange rate? Right now Japanese consumers and workers would be likely to give a very different answer to its government. But all readers of this blog can play that game, whatever country you are in, what do you think is the “right” exchange rate for it? I will be fascinated to see the replies….
There is a country that may be about to engage in this game for real as Scotland considers not only independence but what currency it might have. Let me drop a hint as so much depends on whether it discovers any more oil or gas as at that point attaching to a larger currency gets much more attractive.