Whoever fires the next shot in the lead-up to a brewing global currency war, one thing is clear: the shooter won't be incoming Bank of England governor Mark Carney.
In his appearance before a UK parliamentary committee overnight, Carney stressed that any rethink of British monetary policy should be cautious and slow-moving.
Carney delivered his first views on how he expects to revive Britain's stagnant economy. And despite expectations that he would come into the testimony with guns blazing – perhaps pushing for stronger stimulus, targeting nominal GDP over inflation-based targets or following outgoing BoE Mervyn King's assertion that the British pound needs to be cut by 25 per cent to revive Britain's economy – Carney made it clear he intends to keep his powder dry, at least until July when he departs his current Bank of Canada post to take up the reins at the BoE.
The British pound rose after Carney's testimony, reflecting the fact that he did not push for looser monetary policy. The pound rose 0.27 per cent, to $US1.57. Also overnight, the Bank of England said it would keep interest rates on hold at 0.5 per cent and quantitative easing unchanged at £375 billion.
Lately the pound has fallen to its lowest in 15 months against the euro and lowest in five months versus the US dollar. Any suggestion from Carney once he begins his five-year term at the Bank of England that he will push for an easier monetary policy could send the pound sharply lower.
When it comes to the simmering currency war, Carney likely has little choice but to join the fray. Already, many of Britain's competitors have indicated a desire to actively dampen their currencies. Earlier this week, French President François Hollande urged Europe to actively lower the value of its euro, saying a strong euro is hurting the region's ability to boost growth and productivity.
But a currency war is not in Britain's best interests. Its manufacturing-based, natural resources-deprived, import-reliant economy risks being on the losing end of a battle driven by export-driven economies.
Carney's 45-page written submission to the Treasury Select Committee ahead of his testimony includes two sobering charts that illustrate not only how Britain might fare in a currency war, but also the extent of the challenge he, the Bank of England and the British government face in trying to stimulate real, sustainable growth without resorting to short-term, artificial measures.
The first chart (on page 38 of the written submission) shows the extent to which the UK remains dependent on slow-growing, advanced economies. Fully 66 per cent of its 2011 exports went to the likes of the US, Europe, Japan and Australia, while only 12.9 per cent went to China, India, Russia and other emerging economies.
The second chart (on page 39) shows the extent to which Britain – and for that matter Canada, where Carney has led the Bank of Canada since 2008 – is losing the global export game. Between 2000 and 2011, Britain lost a significant amount of its global export market share, leaving it with little by way of structural economic strength to build upon in a recovery.
"Given the UK's poor export performance, increasing market share in emerging markets will require sustained efforts to develop trade, technical and academic partnerships,” Carney wrote. "In tandem, business needs to improve its competitiveness, source new suppliers, and prepare to manage in a more volatile environment.”
He added that the imbalance in developed vs emerging economies and slow-growth vs high-growth economies will dramatically change capital flows, warning that investors, businesses and policymakers need to be better aware of the consequences, and opportunities, emerging from the shift.
"Investors from advanced economies are substantially overweight in their home markets: advanced economies represent half of current global GDP, but their equity market capitalisation is nearly three-quarters of the global capital market capitalisation,” Carney wrote. "A reallocation of five per cent of advanced-economy portfolios to emerging markets translates into a potential flow of $2 trillion, or 30 times portfolio equity flows to all emerging markets.”
On one closely-watched issue, Carney indicated he intends for the central bank to maintain the inflation-based target, rather than the nominal GDP target he had earlier floated.
"In my view, flexible inflation targeting – as practiced in both Canada and the UK – has proven itself to be the most effective monetary policy framework implemented thus far,” Carney told British MPs in softening talk of radical policy shifts once he takes over the central bank. In his written submission, he added that, "As a result, the bar for alternation is very high”.
He also said that evidence from his time at the Bank of Canada suggests that as the scale of QE increases, returns from it decrease.
Despite Carney's talk of long-term, sustained steps to structurally change the focus and composition of the British economy, it is unlikely he will avoid making any moves that spook British and global markets. Carney has been brought in to move quickly on boosting Britain's economic growth, and he knows it.
With Britain's economy facing the threat of a triple-dip recession and its pound losing its lustre, any efforts Carney makes to address the former – say, easing monetary policy – may adversely affect the latter, sending Britain headlong into a global currency war whether Carney likes it or not.