The so-called currency war is a fizzer with most of the recent currency moves having more to do with the key fundamentals underlying each country rather than there being a market distortion in exchange rates that gives one country an unfair competitive advantage.
The central banks of the G7 countries – the US, France, Britain, Germany, Japan, Canada and Italy – have implemented extremely expansionary monetary policy in the wake of the global financial crisis, in most cases including quantitative easing. Since this easy money policy approach started some four years ago, movements in the US dollar, the euro, the Japanese yen and British pound all seem to be a reasonable reflection of the economic fundamentals, despite some of the more recent moves in the yen being large and the clear result of macroeconomic policy changes.
The reason for the chatter about currency wars relates to the sharp fall in the yen which has been the result of the recently elected government of Shinzo Abe starting a reform agenda to revamp and reflate the Japanese economy. Added to that were comments from French Prime Minister Francios Hollande that the eurozone would do more to control the value of the euro. Hollande was of the view that the recent rise in the euro was acting as a constraint on economic recovery.
Currency matters are gaining headlines, even if for the wrong reasons.
Ahead of the G20 finance ministers meeting this weekend in Moscow, the G7 ministers issued a statement overnight which reiterated their "longstanding commitment to market determined exchange rates” and that countries "will not target exchange rates”.
This was immediately interpreted to mean that there was no concern from policy makers with recent yen depreciation. There was confusion in the market when an unnamed G7 official then issued a statement saying investors had "misinterpreted” the statement with an inference that there was some internal angst about the yen depreciation. The yen rose more than one per cent after that comment.
Whatever the mutterings of the G7 and their poor communications platform, a proper examination of the currency fundamentals suggests recent currency moves, including of the yen, are warranted.
While calculations of "fair value” for a particular currency are subjective and open to debate, one has to only consider Japan’s economic circumstances to see why a weaker yen is fully justified and that more to the point, the yen was overvalued in recent years.
For around two decades, Japan has had deflation in the general economy, asset prices remain massively (60 to 75 per cent) lower than in the late 1980s peaks and the real economy has swung in and out of recession on half a dozen occasions. This dismal picture has remained in place despite the Bank of Japan setting interest rates near zero and various governments embarking on fiscal stimulus. There is a massive pool of domestic savings that remains unspent.
It is entirely fair and reasonable to say the recent depreciation of the yen is fundamentally based given this background of economic malaise.
The appreciation of the euro has been modest despite Hollande’s concerns. It has risen around 10 per cent from the 2012 low. At around 1.35 to the US dollar, the euro is, however, still well below mid-2011 levels and is 15 per cent lower than 2008 levels. On any medium-term assessment, the euro is in the middle of a range and it too is probably near fair value.
The 2012 low point for the euro occurred when there were genuine fears of a sovereign default or a eurozone break up. The recovery in recent months reflects more favourable conditions in the real economy and a slow but steady normalisation in government bond markets.
In the UK, the pound has been weak for many years as a result of the Bank of England’s combined near zero interest rates and unprecedented level of QE. There is no doubt that the weakness of the pound, which has fallen the most of all the G7 currencies over the last few years, reflects dismal fundamentals, highlighted by the fact the UK economy is smaller now than in 2008 and the prospects for economic recovery remain dim.
All of this suggests there is nothing glaringly wrong with the weak Japanese yen, British pound or the moderate rise in the euro. What currency war? Apart from the obvious and inevitable short-term currency volatility, the floating exchange rate system for the major currencies is working well and recent currency moves are well founded.
The issue of currency targeting is more an issue outside the G7, most notably China when its currency peg is a tool of economic management. On that score, there may be legitimate grounds to suggest China is keeping the yuan artificially low which is providing a competitive boost to China, a point showing up in China’s wide trade surplus.
This is more likely to capture debate at the G20 meeting rather than the recent moves in the yen or euro.