bloomberg brief currency wars

EconomicsCurrenCy

Wars MarCH 11, 2013

insidE:Barry Eichengreen calls for more “currency wars” to bolster growth

sanjay mathur of RBs sees political posturing, not open warfare

david Powell on what constitutes a competitive devaluation

michael mcdonough on currency reserves accumulation

Joseph Brusuelas on the history of currency wars

niraj shah on global capital controls

Brazilian Finance Minister Guido Mantega has accused governments

of engaging in a currency war and Bundesbank President Jens Weidmann

warned against politicizing the value of the yen. In the following pages, we

explore what’s really going on.

ovERviEw david powell, BloomBerg economist

currency war discussion should Focus on Reserve Accumulation, Fair value

As they struggle to boost economic growth, some policy makers have focused on the value of their currencies, with fiscal and monetary policies having already been pushed close to their limits. This focus has sparked talk of a return to the competi-tive devaluations that ended in economic disaster during the inter-war period.

Countries that intervene in the foreign-exchange markets to depress the value of their currencies may be most vulner-able to such accusations. That group includes nations with fixed exchange rates or “hard pegs” and those with “dirty floats” or “soft pegs”.

Intervention results in the accumulation of foreign-exchange reserves. They can signal an undervalued currency.

The foreign-exchange reserves monitor on page 7 suggests Asian countries are most guilty of this practice. They held $6.7 trillion in currency reserves at the end of the most recent reporting period, equal to about 30 percent of GDP. China accumu-lated the most foreign-exchange reserves within Asia. Their holdings totaled $3.3 trillion. That represents about 30 percent of Chinese GDP.

It indicates Switzerland has accumulated the highest level of foreign-exchange reserves among the European countries. They stand at $460 billion. That equals about 73.9 percent of Swiss GDP.

A country that refrains from intervention can still be accused of trying to unfairly control the value of its currency. The two primary instruments of influencing a currency apart from direct intervention are monetary policy and capital controls, though government officials can argue their policies have been prescribed in an attempt to influence other variables, such as inflation, in the case of monetary policy, or to eliminate speculation, in the case of capital controls.

Discussions of those attempts mostly focus on the distance of a currency from its “fair value”. If a currency were close to its fair value and to decline by 30 percent, the move would likely be viewed by policy makers as fundamentally unjustified. By contrast, if a currency were 30 percent above its fair value and to decline by 30

percent, the move would seem to be justi-fied by fundamentals.

The most often-used tools for currency valuation are purchasing-power-parity models. They calculate equilibrium exchange rates, based on the theory that the long-term exchange rate is de-termined by the ratio of prices between two countries. A higher (lower) level of inflation in one country relative to another will lead to a weaker (stronger) currency. Most economists agree over- or undervaluations of more than 20 percent are unsustainable.

The pound is extremely undervalued according to the PPP calculations of the Bloomberg Brief. It is 22 percent below that equilibrium level versus the euro; 26.6 percent below that figure versus the Swiss franc; 20.7 percent below versus the Norwegian krone; 35.8 percent below versus the Australian dollar; 34.9 percent below versus the New Zealand dollar.

A 10-year moving average of an

Policy makers’ focus on boosting growth has

sparked talk of a return to the competitive devalua-tions that ended in eco-

nomic disaster during the inter-war period.

‘‘

‘‘exchange rate can be used as a comple-ment to a PPP model. Academic studies have shown most deviations from the level implied by PPP should be removed over the course of 10 years. That average value should act as an anchor.

That second metric appears to confirm the undervaluation of the pound. GBP/CHF is 27.1 percent below its 10-year moving average. GBP/NOK is 19.4 per-cent below that figure; GBP/SEK is 21.8 percent below that figure; GBP/CAD is 20.5 percent below that figure; GBP/AUD is 30.1 percent below that figure; GBP/NZD is 26.8 percent below that figure.

Real effective exchange rates can also be used as a valuation metric. They are trade-weighted measures of a currency adjusted for inflation. They tend to revert to a long-term mean, such as the 10-year moving average. Deviations from that average are considered by economists to represent over- or undervaluation.

Switzerland may be able to argue that its intervention is justified because capital flows have caused its currency to veer sig-nificantly from its “fundamental value”. Its real effective exchange rate is still about 6 percent above its 10-year moving average. The PPP model and the 10-year moving average support that conclusion. They show EUR/CHF is undervalued by 10.7 percent and 16.2 percent, respectively.

The Peterson Institute for International Economics has produced its own valu-ation metric called the fundamental ef-fective exchange rate. It is the exchange rate between a foreign currency and the U.S. dollar that is expected to generate the current account deficit or surplus that matches a country’s underlying capital flows. (For more details, see: Cline, Wil-liam R. & Williamson, John. Estimates of Fundamental Equilibrium Exchange Rates, May 2012. Peterson Institute for International Economics, May 2012.)

The authors found Singapore has the most undervalued exchange rate in the world. They estimate the Singapore dollar is 28.5 percent below its fair value versus the U.S. dollar.

The following pages should help our readers navigate these issues.

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03.11.13 www.bloombergbriefs.com Bloomberg Brief | Economics 2

JAPAnEsE Policy sanjay mathur of rBs

yen weakness, currency wars signal Political Posturing, not Economic Reality

Finally, regional production chains have changed over the last decade. Several economies have established regional production networks by specializing in intermediate products. According to esti-mates by the IMF, the share of total Asian exports that were intra-regional rose to 55 percent from 45 percent between 2000 and 2009. Of that increase, intermediate exports accounted for about 70 percent.

That shows depreciation of a single cur-rency does not necessarily raise competi-tiveness; the higher import costs of inter-mediate products can raise manufacturing costs. The IMF also concluded that gains from regional devaluation can be more beneficial than those from the devaluation of individual currencies.

Japan’s new leaders have increased pressure on the central bank to loosen monetary policy to such an extent it has sparked concern about global competitive devaluations, or currency wars. I believe those concerns are steeped in political posturing rather than economic reality and any managed depreciations will only be effective in the short term.

The global reaction to the Bank of Japan’s decision to fight deflation by adopting a 2 percent inflation target and shifting to “open-ended” asset buying has been loud and clear. Policy makers from South Korea to Germany and Brazil have viewed the depreciation as a competi-tive devaluation. The yen has dropped 17 percent against the dollar since November 2012, and concern about a currency war between central banks has risen sharply.

Japan’s moves have perhaps rattled cen-tral banks in Asia more acutely because they follow the expansion of the balance sheets of the Federal Reserve and the European Central Bank over the past two years. Based on recent announcements, the expansion of the BOJ’s balance sheet in fact looks larger than that of the Fed or the ECB. In response, the Philippines and Thailand have threatened to introduce their own capital controls.

Would capital controls or currency de-valuations by other central banks actually help a country’s competitiveness in the long term? Looking behind the headlines and the political maneuvering to the eco-nomic reality, the answer is no.

First, currencies in non-Japan Asia remain competitive against the yen. The Bloomberg-JPMorgan Asia Currency Index shows the yen is still relatively strong versus other Asian currencies. It was weaker in the run-up to the global financial crisis, and for much of the time since. Exports from non-Japan Asia have been weak, though that is because global demand has been weak, rather than be-cause of encroachment by Japan.

The Asian region has also made sub-stantial productivity gains against Japan. For the most part, since 2011, manufac-turing productivity growth in non-Japan Asia has outperformed that of Japan.

The latter has also been losing market share in global exports, even prior to the financial crisis, when the value of the yen was more competitive. During that period, exports did not rise proportionately for all non-Japan Asia economies, though that can be attributed to a continuing loss of competitiveness against China.

Japan’s moves have per-haps rattled central banks

in Asia more acutely because they follow the

expansion of the balance sheets of the Fed and the

ECB over the past two years.

‘‘‘‘

That said, capital controls in Asia can-not be ruled out. In the short term, such controls could be effective, both because of a genuine slowdown in currency flows and because of the concern they bring to financial markets. The recent weakness in the Korean won is an example of this psychosis. The Thai baht and Philippine peso may also feel the pressure.

In the long term, however, capital con-trols are unlikely to reverse medium-term upward pressures on currencies. That is because the dominant source of appre-ciation pressure on most currencies has been the current-account surplus and not debt-portfolio capital, the principal target of capital controls. While current-account surpluses have fallen in most economies, they remain the largest component of the balance of payments. Thailand is an exception in the probable set of countries that could impose controls, but even so, its balance of payments has been bolstered by foreign direct investment, and that is not the target of capital controls.

Outside Asia, the consumption-driven U.S. economy is unlikely to feel any threat from Japan’s actions. It may make Japa-nese imports less expensive and in turn help lift consumption in the U.S. economy.

Europe is different — it could benefit from a weaker euro. Domestic demand is weak because of fiscal austerity, so the region’s reliance on exports is greater. That makes a competitive euro important.

European policy makers will doubtless oppose Japanese monetary policy, though they are unlikely to take further action as long as currency traders, rather than the BOJ, dictate the strength of the yen. If that changes, it could open up the possibility of tariffs on Japanese imports into the euro area or other punitive measures.

It is one thing for developing countries to engage in currency wars, quite another when the developed world does it. That sets a bad precedent and creates the po-tential for tit-for-tat actions. From crisis, we could move to protectionism. In the long term, that could destabilize an already precarious economic recovery.Sanjay Mathur is head of research and strategy at

Royal Bank of Scotland in Singapore.

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cuRREncy vAluAtions david powell, BloomBerg economist

Currency Current PPP Valuation 10-Year MA ValuationEUR/USD 1.2995 1.2484 4.1% 1.3167 -1.3%USD/JPY 93.93 82.62 13.7% 100.76 -6.8%GBP/USD 1.4997 1.7200 -12.8% 1.7281 -13.2%USD/CHF 0.9483 1.1297 -16.1% 1.124 -15.6%USD/NOK 5.7155 6.2825 -9.0% 6.1680 -7.3%USD/SEK 6.4082 5.8043 10.4% 7.1348 -10.2%USD/CAD 1.0313 0.9809 5.1% 1.1253 -8.4%AUD/USD 1.0244 0.7545 35.8% 0.8461 21.1%NZD/USD 0.8274 0.6176 34.0% 0.7064 17.1%EUR/JPY 122.06 100.96 20.9% 132.17 -7.6%EUR/GBP 0.8665 0.7105 22.0% 0.7680 12.8%EUR/CHF 1.2322 1.3805 -10.7% 1.47024 -16.2%EUR/NOK 7.4275 7.6776 -3.3% 8.0709 -8.0%EUR/SEK 8.3274 7.6152 9.4% 9.3453 -10.9%EUR/CAD 1.3402 1.1987 11.8% 1.4723 -9.0%EUR/AUD 1.2686 1.6197 -21.7% 1.58167 -19.8%EUR/NZD 1.5706 1.9789 -20.6% 1.8798 -16.4%GBP/JPY 140.86 142.10 -0.9% 175.79 -19.9%GBP/CHF 1.4221 1.9367 -26.6% 1.9519 -27.1%GBP/NOK 8.571 10.8060 -20.7% 10.6403 -19.4%GBP/SEK 9.61 9.2521 3.9% 12.2907 -21.8%GBP/CAD 1.5466 1.6872 -8.3% 1.9459 -20.5%GBP/AUD 1.4639 2.2798 -35.8% 2.095 -30.1%GBP/NZD 1.8125 2.7852 -34.9% 2.4746 -26.8%CHF/NOK 6.028 5.5612 8.4% 5.537 8.9%CHF/SEK 6.7582 5.4896 23.1% 6.4147 5.4%NOK/SEK 1.1212 0.9166 22.3% 1.1582 -3.2%CAD/CHF 0.9195 1.1517 -20.2% 0.9993 -8.0%CHF/JPY 99.05 73.13 35.4% 89.68 10.5%

NOK/CAD 0.1804 0.1562 15.5% 0.1823 -1.0%SEK/CAD 0.1609 0.1929 -16.6% 0.1577 2.0%SEK/JPY 14.66 13.20 11.0% 14.17 3.5%CAD/JPY 91.08 84.22 8.1% 89.80 1.4%

AUD/NOK 5.8550 4.7402 23.5% 5.1572 13.5%AUD/SEK 6.5647 6.8784 -4.6% 5.9737 9.9%AUD/JPY 96.22 62.33 54.4% 83.82 14.8%AUD/CHF 0.9714 0.8524 14.0% 0.9333 4.1%AUD/CAD 1.0565 0.7401 42.7% 0.9372 12.7%AUD/NZD 1.2381 1.2217 1.3% 1.1941 3.7%NZD/NOK 4.7292 3.8799 21.9% 4.3199 9.5%NZD/SEK 5.3023 3.1094 70.5% 4.9988 6.1%NZD/JPY 77.715 51.02 52.3% 70.563 10.1%NZD/CHF 0.7846 0.6977 12.5% 0.7851 -0.1%NZD/CAD 0.8533 0.6058 40.9% 0.7867 8.5%

Purchasing-power-parity models calculate equilibrium exchange rates, based on the theory that the long-term exchange rate is determined by the ratio of prices between two countries. A higher (lower) level of inflation in one country relative to another will lead to a weaker (stronger) currency.

These PPP calculations use June 1991 as a base period because global imbal-ances (the sum of the absolute value of the current-account deficits and sur-pluses, as percentages of gross domestic product, of Australia, Canada, Germany, Japan, Norway, Switzerland, the U.K. and the U.S.) were smaller at that time than during any other quarter since data for those countries has been available. That suggests exchange rates in the G-10 were closest to their equilibrium values in the second quarter of 1991.

The Swedish krona is an exception. These PPP calculations for the currency use January 1993 as a base period to exclude the volatility created by the Swedish bank-ing crisis of the early 1990s.

The problem of choosing the correct base period can be circumvented by using a 10-year moving average of the exchange rate as an equilibrium rate. Academic studies have shown that most deviations from the level implied by PPP should be removed over the course of 10 years. The average value during this period should act as an anchor.

The blue highlights show undervaluations of less than -20 percent; overvaluations of 20 percent or higher are highlighted in orange.

The British pound is extremely undervalued according to the purchasing-power-parity calculations of the Bloomberg Brief.

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vAluAtion

For the currencies of developed economies, real effective exchange rates (the trade-weighted exchange rate adjusted for inflation) tend to revert to a long-term mean, such as the 10-year moving average. Deviations from that average are considered by economists to represent over- or undervaluation.

-30% -20% -10% 0% 10% 20% 30%

Japan

U.S.

U.K.

Euro Area

Canada

Australia

New Zealand

Switzerland

Sweden

Norway

Deviation ofREER From 10-Year MovingAverage (%)

Source: Bloomberg

Fundamental Equilibrium Exchange Rates ovERvAluAtion

oF REER countRy ovERvAluAtion vs usd

10.6% Australia 6.8%

15.2% new Zealand 13.4%

-3.1% china -5.9%

-7.6% Hong Kong -12.9%

1.3% india -1.4%

1.1% indonesia -4.7%

1.1% Japan -2.4%

1.0% Korea -2.4%

-4.1% malaysia -10.2%

1.0% Philippines -4.5%

-24.5% singapore -28.5%

-8.5% taiwan -13.3%

1.1% thailand -3.0%

0.7% israel -0.8%

0.8% saudi Arabia -2.2%

5.9% south Africa 3.8%

0.5% czech Republic -0.4%

0.9% Euro Area -0.4%

0.5% Hungary -0.3%

0.7% norway -1.5%

2.2% Poland 1.4%

0.5% Russia -0.4%

-13.7% sweden -14.4%

-4.3% switzerland -5.5%

23.2% turkey 21.9%

0.8% united Kingdom -0.5%

1.2% Argentina 0.2%

2.3% Brazil 0.4%

0.5% canada -0.4%

1.1% chile -0.8%

0.9% colombia -0.1%

0.5% mexico -0.5%

2.2% united states 0.0%

0.7% venezuela -1.0%

Real Effective Exchange Rates

Source: Peterson Institute for International Economics

CHF REER is about 5 percent above its 10-year moving average.

The Singapore dollar is 28.5 percent below its fair value versus the U.S. dollar.

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intERvEntion PoliciEs niraj shah, BloomBerg economist

The table shows the intervention policies of various countries in the foreign-exchange markets. The nations highlighted in red are the most likely to intervene, based on historical moves and statements from central bank policy makers.

mAJoRs% oF

woRld outPut

Policy RAtE

% cHAngE in cuRREncy

Holdings (yoy)commEnt

u.s. (usd) 21.42 0.25 -2.6Qe may have weakened usD. Fed purchases $40 billion of mortgage-backed securities per month.

Euro Area (EuR) 18.69 0.75 6.5 eCB avoids talking about FX. Takes view FX should be determined by fundamentals.

Japan (JPy) 8.38 0.1 -2.8BOJ talking down JPy. Pursuing aggressive monetary easing by setting inflation target at 2 percent.

u.K. (gBP) 3.49 0.5 14.4BOe has talked about impact of stronger GBP. Governor King voted to expand 375 billion-pound Qe program.

canada (cAd) 2.48 1 4.2 BOC Governor Carney denounced exchange rate manipulation. Australia (Aud) 1.97 3 -3.9 rBa has not signaled concerns over auD strength.

switzerland (cHF) 0.94 0 72.6snB set a minimum exchange rate of CHF1.2 vs eur to prevent currency strength in september 2011.

sweden (sEK) 0.77 1 34.4 Deputy Governor ekhol has talked about having ammunition to prevent seK gains.norway (noK) 0.69 1.5 5.2 nOK strength was offset with rate cuts last year.Hong Kong (HKd) 0.36 0.5 9.6 HKMa operates a pegged exchange rate system. HKD vs usD managed between 7.75 and 7.85.new Zealand (nZd) 0.23 2.5 3.5 rBnZ Governor Wheeler ruled out Qe. Claims rate cuts have minimal impact on nZD.

EmEARussia (RuB) 2.65 8.25 5.2 CBr uses an exchange rate target. a free float target due in 2015.turkey (tRy) 1.11 5.5 34.4 CBrT uses the interest rate corridor and reserve requirement ratio to contain Try appreciation.Poland (Pln) 0.74 3.25 8.5 nBP willing to intervene in FX if excess volatility in PLn.south Africa (ZAR) 0.58 5 -0.1 sarB actively accumulates reserves.isreal (ils) 0.35 1.75 1.7 Central bank willing to intervene to curb ILs appreciation.czech Republic (cZK) 0.31 0.05 CnB may use FX intervention to weaken currency, having reduced the policy rate to 0.05 percent. Romania (Ron) 0.26 5.25 -0.1 uses managed floating target to keep eur versus rOn between 4.3-4.6.Hungary (HuF) 0.20 5.25 -4.2 new nBH governor may target a weaker HuF.

lAtin AmERicABrazil (BRl) 3.54 7.25 5.6 BCB intervenes to keep usD vs BrL range-bound.mexico (mXn) 1.65 4.5 11.3 Central bank set up mechanism in 2011 to prevent MXn weakness. no policy on MXn strength.Argentina (ARs) 0.64 12.2 -9.9 BCra intervenes to weaken currency. colombia (coP) 0.48 3.75 17.6 The government and central bank buy usD to prevent COP strength. venezuela (vEF) 0.45 16.43 -9 The government devalued the VeF to 6.3 from 4.3 against usD on Feb. 8.chile (clP) 0.36 5 1.9 BCCH considering FX intervention. Halted usD buying in 2011.Peru (PEn) 0.25 4.25 28.5 BCrP intervenes to slow the pace of Pen strength rather than reverse the trend.

AsiAchina (cny) 10.46 6 4.1 PBOC sets usD against Cny rate. PBOC moving toward FX liberalization. india (inR) 2.64 7.75 -1.1 rBI intervenes in FX during currency volatility.south Korea (KRw) 1.60 2.75 5.6 new government tolerating FX appreciation. Increasingly uses macro prudential measures.indonesia (idR) 1.21 5.75 -2.9 BI intervenes in FX to combat IDr weakness.taiwan (twd) 0.51 1.88 2.5 Intervenes in FX to defend against an appreciation in TWD. thailand (tHB) 0.49 2.75 2.1 BoT uses FX intervention to contain volatility.malaysia (myR) 0.41 3 4.6 BnM allowed Myr to strengthen. Only intervenes in excessive volatility.singapore (sgd) 0.34 0.04 5.4 The rise in sGD versus usD suggests Mas is willing to overlook currency appreciation.Philippines (PHP) 0.32 3.5 10.2 BsP uses FX intervention and macro prudential measures to smooth appreciation in PHP. vietnam (vnd) 0.18 9 sVB has left the usD vs VnD rate unchanged since December 2011.Red highlights countries most likely to intervene in FX

Source: Bloomberg

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FX REsERvEs michael mcdonough and nipa piBoontanasawat, BloomBerg Brief

FX Reserves by Country

totAls FX REsERvEs % oF gdP % oF totAl 3m% y/y%

asia 6,668,659 30.1% 60.4% 1.0% 2.8%europe 2,028,592 4.5% 18.4% 1.9% 15.7%africa/Middle east 1,450,748 33.5% 13.1% 5.0% 13.2%north america 266,579 1.4% 2.4% -0.5% 7.4%south america 619,554 13.8% 5.6% 1.0% 7.6%All 11,034,132 11.7% 100.0% 1.6% 6.7%China 3,311,590 40.1% 30.0% 0.8% 4.1%Japan 1,191,627 19.9% 10.8% -0.4% -2.8%saudi arabia 648,710 98.7% 5.9% 7.1% 23.4%russia 475,261 24.3% 4.3% 1.6% -0.4%switzerland 460,487 73.9% 4.2% 4.3% 80.9%Taiwan 406,560 87.2% 3.7% 1.8% 4.2%Brazil 376,073 15.5% 3.4% -0.4% 6.1%south Korea 328,910 28.6% 3.0% 1.7% 5.6%Hong Kong 321,000 124.4% 2.9% 6.4% 9.6%India 259,786 13.3% 2.4% 0.4% 0.1%singapore 258,844 96.6% 2.3% 1.8% 5.4%eurozone 219,849 1.8% 2.0% 0.7% 5.6%algeria 186,960 90.5% 1.7% 1.7% 4.7%Thailand 171,258 45.4% 1.6% 0.3% 2.1%Mexico 165,005 14.2% 1.5% 1.5% 11.6%Malaysia 134,902 43.9% 1.2% 1.8% 4.6%Indonesia 108,780 12.2% 1.0% -1.4% -2.9%Libya 107,571 126.4% 1.0% 0.5% 3.3%Turkey 104,999 13.4% 1.0% 5.8% 35.6%Poland 100,317 21.3% 0.9% 3.6% 11.9%Philippines 85,274 35.4% 0.8% 4.3% 10.2%Denmark 82,292 26.6% 0.7% 4.8% 5.2%Israel 78,400 31.8% 0.7% 3.3% 1.7%u.K. 64,947 2.7% 0.6% 1.6% 15.5%Peru 58,161 29.0% 0.5% 6.8% 28.5%Canada 55,243 3.1% 0.5% 0.7% 4.6%

0%

2%

4%

6%

8%

10%

12%

14%

16%

0%

10%

20%

30%

40%

50%

60%

70%

Asia Europe Africa/ME N_America S_America

FX Reserves as % of World Total (ls)FX Reserves YoY% (rs)

Source: Bloomberg

FX Reserves By Region

0

100

200

300

400

500

600

700

0

500

1000

1500

2000

2500

3000

3500

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013China (ls) Japan (ls) Saudi Arabia (rs) Russia (rs)

Biggest Holders of FX Reserves

Source: Bloomberg

USD

Bill

ions

USD Billions

Since the Asian financial crisis, countries in the region have built up foreign-exchange reserves to record levels. Asia currently holds 60 percent of global reserves, with China being the big-gest holder, while Japan, Taiwan, South Korea, Hong Kong and India occupy five of the top 10 spots with the largest amount of reserves. Even so, foreign reserves in Asia grew 2.8 percent in the latest period from a year earlier, the slowest pace when com-pared with other regions, suggesting Asian economies may not be aggressively pursuing weaker currencies. In Europe, where the amount of reserves is only a third of Asia’s, they expanded by 15.7 percent, more than five times the pace in Asia.

Asia’s FX Reserves, While Biggest, Grew Slowest

High Level of FX Reserves Raises Questions

Still, the high level of foreign exchange reserves of the world’s two biggest holders — China and Japan — has raised questions over their objectives. Reserves in China, which has been accused by the U.S. of keeping its currency weak to promote exports, swelled to $3.31 trillion at the end of 2012 from $286.4 billion a decade ago, representing a pace of $829 million per day. Yet, the yuan strengthened 33 percent against the dollar in that period. Japan’s foreign reserves have ballooned since the global financial crisis because of the yen’s status as a safe haven. China’s reserves stood at 40 percent of its GDP, while Japan’s are at 20 percent.

FX Reserves as Share of Total

Note: FX reserves are in USD millions for the latest reported period.

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modern currency crises, devaluations and Regime changes since collapse of gold standard

HistoRicAl ovERviEw joseph Brusuelas, BloomBerg economist

Tensions between policymakers due to volatility in foreign-exchange markets pale in comparison to those induced by the policies of the Great Depression. That pe-riod saw tariff and non-tariff barriers imposed by countries attempting to arrest the economic slide that characterized the global economy in 1929-1939. The coordination be-tween the large global central banks that are engaging in competitive QE has avoided the outbreak of protectionism that was observed during the 1930s. In Thucydides’ History of the Peloponnesian War, he stated: “The strong do what they can and the weak suffer what they must.” As the large central banks attempt to boost their economies via QE, small and developing countries will likely have to adjust by accepting faster inflation or accommodate to these policy changes by accepting currency appreciation.

u.s. currency Policy 1969-2013

yEAR countRy commEnt1929-1939 Beggar-thy-neighbor policies in Great Depression all countries on list devalued their currencies versus gold by more than 10 percent.

1930 spain spain devalues five times between 1929-1937.1931 austria, Italy, spain austrian real GDP contracted 24.5% from 1929-1933.

1932austria, Denmark, Finland, Greece, Japan, norway,

sweden, spainJapan departs from gold standard in 1931 and devalues yen over next three years.

1933 Canada, Denmark, Greece, Japan, u.s., yugoslaviaVolatility in Canadian dollar which returned to parity with usD by 1934. Bank of Canada

started operations 1935.1934 Canada, Denmark, Greece, Japan, u.s., yugoslavia reer of Danish Krone declined by over 20% from 1929-1939.1935 Belgium Belgian franc devalued by 28% in 1935.1936 Italy, romania, spain Italian lira devalued by over 20% between 1935-1937.1937 Czechoslovakia, France, Italy, spain, switzerland switzerland exited gold standard in 1936 and franc devalued by 30% through 1938.1938 France, netherlands France departs gold standard in 1936, 28% depreciation in 1938.

collAPsE oF FiXEd dollAR RAtE to gold And ERA oF FloAting EXcHAngE RAtEs

1971 u.s. abrogates Bretton Woods agreement nixon imposes 10% import tax when gold convertibility suspended. 1985 Plaza accord G-7 agrees to greater policy coordination to improve function of floating exchange rate system.1992 EuRoPEAn monEtARy systEm cRisis

Italy withdraws from erM Lira devalued by 7%.u.K. withdraws from erM 29% adjustment in sterling between 9/92 & 2/11.

1993 tEquilA cRisis1994 Mexico, argentina and Brazil 58% depreciation in Mexican peso between 2/94 & 3/95.1997 AsiAn FinAnciAl cRisis

Hong Kong, Indonesia, Malaysia, Philippines, south Korea

57% depreciation in south Korean won in 1997.

1998 RussiAn FinAnciAl cRisisrussia, Brazil, Hong Kong, Mexico 48% depreciation of the Brazilian real

2000-2002 argentina regime Changeeconomic collapse, bank runs, debt default and end of fixed exchange rate to u.s. dollar.

resulted in 80% devaluation of peso.2007-??? ERA oF comPEtitivE quAntitAtivE EAsing

u.s., euro area, Japan, u.K. Central bank asset purchases, currency depreciations and volatility.Source: Beth Simmons Who Adjusts? Domestic Sources of Foreign Economic Policy During the Inter-War Years, Princeton University Press, Bloomberg

AdministRAtion PERiod Policy

nixon/Ford 1969-1971 Benign neglect

1971-1976 abrogated gold standard & devaluation

carter 1977-1978 supported dollar depreciation

1978-1980 Intervened to reverse dollar depreciaiton

Reagan/Bush 41 1981-1984 Benign neglect

1985-1986 Plaza accord and suppport of dollar weakness

1987-1992 Promoted dollar stability

clinton 1993-1996 support of weak dollar

1997-2000 strong dollar policy

Bush 43 2001-2007 Benign neglect

2008-2009 supported weak dollar policy

obama 2009-2013 supports weak dollar policy

Source: Bloomberg

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comPAny Focus BloomBerg news

watchesSwatch Group AG said its sales last year would have been 500 million francs higher if the franc were still at 2010 levels. “Foreign currencies stabilized somewhat against the Swiss franc but remain sig-nificantly weaker than two years ago,” the company said in a statement. (Feb. 4)

— Anchalee Worrachate

luxury goodsLVMH Moet Hennessy Louis Vuitton SA raised some prices by an average 12 per-cent at its flagship brand in Japan to offset the effect of the yen’s slide on sales. “We are an importer, so the weakening yen and rising raw material prices are part of the reason for the price increase,” spokes-woman Kaori Fuse said. The increase is the largest since the Japan unit was established in 1978. (Feb. 20).

— Yuki Yamaguchi and Kenneth Maxwell

Harry Winston Diamond Corp. will raise jewelry prices in Japan as the yen’s drop makes imports more expensive. The retail-er got about 12 percent of revenue from Japan in the year ended January 2012, according to Bloomberg data. (March 6)

— Yuki Yamaguchi

wineCasella Wines Pty., An Australian wine maker, is looking at bottling so-called bulk wine overseas to cut costs. “Bottling overseas would carry risks” as local op-erations would become more competitive should the Australian dollar decline, Man-aging Director John Casella said. “The danger is you do it and you’re in no man’s land — you’re over there when you should be here.” Casella has announced plans for a more expensive wine to sell at around $10 a bottle and entered a potential beer joint venture with Coca-Cola Amatil Ltd.

These economy-related corporate anecdotes are taken from Bloomberg News stories and focus on the impact of currency movements.

as it seeks to minimize the exposure of its low-priced wine to the strength of Austra-lia’s currency. “We’ve been squeezed by the exchange rate,” he said. “I don’t see there’s any Australian company that hasn’t been squeezed by that.” (Jan. 15)

— David Fickling

AirlinesSwiss International Air Lines Ltd. CEO Harry Hohmeister said he’d prefer the Swiss franc to weaken against the euro. “We can be very satisfied that the SNB decided to set the threshold at 1.20 against the euro,” he said. A rate of 1.35 francs per euro would be “realistic when you compare the economies, but I would not recommend that the SNB intervenes in that regard.” (Feb. 6)

— Jennifer M. Freedman

AutomobilesHonda Motor Co. claimed the weaker yen isn’t giving the Japanese company an advantage in the U.S. “I defy anybody, when we’re building 90 percent of what we sell here, to say we have a currency advantage,” said John Mendel, executive vice president of U.S. sales. “I don’t think the current level of 90-plus yen to the dollar is a cause for alarm.” The American Automotive Policy Council said in January that President Barack Obama should tell Japan’s new government that the U.S. will retaliate for policies aimed at weakening the yen. “Nobody worried about Japan” when the yen “went from 115 to 78, and said ‘Geez, I hope those guys are OK,’” Mendel said. “Now all the sudden it’s moderately off deathbed kind of rates, and everybody’s going ‘Unfair.’ Let’s focus on the quality of products. Let’s focus on the customer.” (Feb. 9)

— Craig Trudell

Nissan Motor Co. CEO Carlos Ghosn, who has called 100 yen to the dollar the “neutral” value for the Japanese currency, said the yen should weaken further. The yen is “still far from neutral territory,” he said. (Feb. 26)

— Anna Mukai and Yuki Hagiwara

Volkswagen AG plans to benefit from lower labor costs and hedge against unfa-vorable currency fluctuations between the dollar and euro by building its best-selling Golf hatchback in Mexico. “With its exist-ing infrastructure, competitive cost struc-tures and free-trade agreements, Mexico is the ideal location to produce the Golf for the American market,” said Hubert Waltl, head of production at VW’s passenger car brand. (Jan. 25)

— Christoph Rauwald

vehicle PartsLinda Hasenfratz, CEO of Linamar Corp., a Canadian maker of auto parts, said a strong currency is an opportu-nity for Canadian companies to expand abroad, instead of threatening manu-facturers such as her firm. “I like having a stronger dollar, I think it makes us a stronger country,” she said. “We can find ways to compete, and develop strategies that allow you to compete, and focus on innovation as your primary path to com-petitiveness, not a low dollar.” Linamar has operations in Mexico, Hungary, Ger-many, Asia and the U.S., and that diverse base provides a hedge against currency fluctuations. “We’re pretty much naturally hedged,” Hasenfratz said. “That’s another strategy Canadian companies should be using, is to try to create as natural a hedge as you can so you’re not impacted by changes in the dollar.” (Feb. 8)

— Ari Altstedter

Hankook Tire Co. in South Korea antici-pates its exports to be hurt as Japan’s success in driving down the yen gives Japanese companies an advantage. “The Japanese government under Abe is trying to get their competitiveness by devaluing the yen against other currencies,” said Lee Soo Il, head of Hankook Tire’s China operations. “Short term, it’s going to work because they have price competitiveness.” Hankook is working to overcome the un-favorable currency by improving product quality, strengthening its brand image and marketing. “Exports are going to be af-fected a little bit,” Lee said. “Already, some are saying that Japanese products are reducing their prices.” (Feb. 28)

— Alexandra Ho

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Q: How serious are the present so-called currency wars compared with currency manipulation in the past? A: The most direct parallel is from the 1930s, when virtually all countries turned to expansionary monetary policies in response to the Great Depression. That had the effect of pushing their currencies down in the foreign exchange markets one at a time. People misunderstand that experience when they call it “beggar thy neighbor exchange rate policy” or “cur-rency war.” In fact, it was reflationary mon-etary policy, which was precisely what the world needed in a period of depression, deflation and slow or negative growth. And that’s where we are now, again. We have slow growth, inadequate recovery or outright recession, in the U.K., continental Europe, Japan and the U.S. The central banks of these economies are all easing and trying to provide more support for reflation and economic growth. The ECB, admittedly, is doing less than the others. If they all do this at the same time, there is no reason that their currencies need to move against one another.

Q: So it is quantitative easing? A: Yes, that’s what the Fed is doing. The Fed is not trying to push down the dollar against the euro or the yen. The goal in Japan is to hit a 2 percent inflation target. The BOJ has suffered from some self-inflicted communication problems, but that is essentially beside the point.

Q: How do you differentiate between the two types of policies? A: You try to identify the strategy and tactics and statements of policy makers.

Barry Eichengreen, a professor of economics at the University of Cali-fornia, Berkeley, spoke to Nipa Piboontana-sawat on Feb. 13 about the so-called currency wars, the weakening of the Japanese yen and how other economies should respond.

q & AEichengreen of Berkeley says world needs more Reflation Policies to support growth

Over the last couple of weeks, Japanese policy makers have made clear that their goal is to raise the rate of inflation to 2 percent, try to end the country’s decade plus of deflation, raise asset prices and get economic growth going again. We’re not mind readers. The best we can do is to try to understand their objectives.

Q: But what the Bank of Japan is doing has the effect of weakening the yen. A: Right, and if they don’t do that, with the Fed, the Bank of England, the Swiss National Bank and other foreign central banks easing but the Bank of Japan not easing, that would be a bad situation for Japanese exporters and producers for the domestic market as well. The over-strong yen has been a problem for the Japanese economy for some time. What’s going on here is that the Bank of Japan and new government are trying to get the economy going again. They are trying to get more demand for Japanese products both at home and abroad. They should be ap-plauded for doing so, if the alternative for Japan is stagnation and no growth.

Q: What should other countries be do-ing in response to the weaker yen? A: What you should be doing depends on local conditions. If you are South Korea, your currency is too strong because the won has been rising against the yen. Your inflation is so low, because Korean core inflation is only 1.2 percent. And growth is so slow, because it’s currently running below 2 percent. Monetary easing, just like the BOJ has been doing, is appropri-ate for your circumstances. On the other hand, if you are Mexico, and growth is too fast, inflation is too high, you are worried about frothy asset markets and now you see your currency rising, the appropri-ate response is to tighten fiscal policy. Tightening fiscal policy translates into less spending at home, less inflation at home, less borrowing by the government, lower interest rates, and therefore a weaker currency. It’s better for other countries to figure out the appropriate domestic policy response than to complain about the BOJ. It makes no sense. If the BOJ were not to

do anything and Japan lapses back into deflation and recession, that wouldn’t be a good outcome for the rest of the world.

Q: What about U.S. policy makers? A: The experience of the 1930s suggests that if the U.S. economy is growing too slowly, if the dollar is too strong, if you need more support for economic growth, then the appropriate response is for the Fed to further ramp up its asset purchase program. More quantitative easing here will be good for demand, good for growth, and limit appreciation of the dollar. I don’t believe the conventional narrative that characterizes the Fed as engaging in currency warfare, any more than I would characterize the Bank of Japan as being engaged in a currency war. It sounds facile to say, but if this is currency war then we need more of it. Expansionary monetary policy in Japan is good for Ja-pan under current conditions. Expansion-ary monetary policy in the U.S. is good for the U.S. under current conditions where growth is slow and inflation is too low.

Q: How much more competitive will the weaker yen make Japanese exports?A: Exchange rates tend to react to mon-etary policy innovations before inflation does, but over time, if the BOJ is success-ful, there will be more inflation in Japan. That’s the goal of the policy. There will be a weaker yen in the foreign exchange markets. The two things then cancel out. Japanese goods are no more or less com-petitive if the yen is 10 percent weaker and Japanese prices are 10 percent high-er. It’s important, in other words, not to confuse nominal and real exchange rates. What matters for export competitiveness is the real, inflation-adjusted exchange rate. Foreign exchange markets and stock markets react overnight to what officials say, but the inflation rate reacts over time. So officials in Brazil and elsewhere who are complaining should be patient and give the Japanese inflation rate more time to catch up.

This interview was edited and condensed. The full version is at {NSN MJGT536TTDS9 <GO>}

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bloomberg brief currency wars

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