Currency wars on our doorstep

The entry of Japan into the global currency war, a kind of echo of its bombing of Pearl Harbour in December 1941 to enter WW2, presents a fresh challenge for policymakers everywhere but especially in Australia.

Since early October, just after Shinzo Abe became leader of Japan's Liberal Democratic Party and it became clear he would win the forthcoming election, Japan has seen one of the fastest currency depreciations since the collapse of the Bretton Woods system in 1971.

But it's against the Australian dollar that the yen has fallen the most. The Aussie has appreciated 19 per cent against the yen since October but only 3 per cent against the US dollar.

"Bold” monetary and fiscal policy was anticipated from Shinzo Abe when he was elected leader of his party and he has not disappointed since becoming prime minister on Boxing Day.

The new Japanese government unveiled a ¥10.3 trillion fiscal stimulus package on January 11, which is expected to scale up to ¥20.2 trillion including private and local government spending, and more importantly Abe is now bullying the Bank of Japan into loosening monetary policy.

He is demanding that the BoJ double its inflation target to 2 per cent and support that with unlimited bond purchases. There is little doubt the governor of the BoJ, Masaaki Shirakawa, will go at least part of the way before his term expires in a few months and he is replaced by someone far more compliant.

Ambrose Evans-Pritchard of London's Daily Telegraph points out that Japan's new economic revolution is a "near copy” of its experiment in the 1930s under the then finance minister Takahashi Korekiyo. He launched a fiscal 'New Deal' before Franklin Roosevelt even became president, compelled the BoJ to monetise debt and devalued the yen by 60 per cent against the US dollar and 40 per cent on the trade weighted index.

Japan's textile, machinery, and chemical exports swept Asia, sparking a global trade war as Britain and India responded.

Last week the deputy chairman of Russia's central bank, Alexei Ulyukayev, became the first to name the problem, saying: "We're on a threshold of a very serious, confrontational actions in the sphere that is known ... as currency wars.”

He went on: "The recent decision by the new government of Japan regarding very protectionist monetary policy ... this is a course towards a sharp depreciation of the yen. Other colleagues from respected central banks and governments already pursue this policy. This is not a path towards global coordination but a separation."

Jean-Claude Juncker, prime minister of Luxembourg and chairman of the Eurogroup of finance ministers, joined in the chorus last week, complaining that the euro is "dangerously high” after a three-month surge against the US dollar and the yen.

Short positions against the yen are now at extreme levels, as market players bravely bet that it's due for a reversal, but there is little doubt that Japan's attempt to escape 20 years of deflation and stagnation has a long way to run.

Over the past five years, the government has launched a series of spending sprees to get the economy moving, but unlike virtually every other central bank in the world, the BoJ has refused to play the game, holding to a strict low inflation target and strong currency regime, and sapping the government's attempt to reflate.

In a way Japan has been acting as a global shock absorber: by not debasing its currency, Japan has allowed its export profits to be slaughtered as Europe, the US and China rebuild their economies on the back of exports. Shinzo Abe has now declared that enough is enough and it's time for Japan to regain its lost market share through discounting.

With the Australian cent seemingly headed back towards parity with the yen at the same time as the dollar is above parity with the greenback, this represents a double challenge for the Australian government and central bank.

Australia's manufacturing sector, based as it is around the carmakers on life support, is under threat not from imports out of the United States but from Japan and, more recently, China.

It's not unlike what happened in 1941. Up to that point, the war was far away; in December 1941 it came to our doorstep.

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