Growth is the summum bonum of economic policy. Tough to arrange at home: stimulus packages don’t work very well, and monetary policy produces lots of fiat money but not very many jobs. The solution: export-led growth—the other guy will buy so much of your goods and services that your economy will grow. There are two ways to make this sort of growth happen. Lower the international value of your currency so that your output is cheaper overseas, or increase productivity at home by lowering labor and other costs and therefore the prices you need to charge foreigners. The first is painless, or so it seems initially. The second requires a politically difficult assault on benefits and union created labor market rigidities.
So it should come as no surprise that France’s president Francoise Hollande, whose largely unreformed labor market has kept unit labor costs so high that French goods—luxury items, food, aircraft—are struggling in world markets, should want the Eurozone to set a “realistic,” i.e. lower, exchange rate for the euro. German’s economy minister, Philipp Roesler, whose country went through the pain of labor market reform and wage restraint, and is having no trouble exporting goods, responds with a definite “nein.” “The objective must be to improve competitiveness and not to weaken the currency.” This is not a theoretical battle. Morgan Stanley estimates that if there were no euro, it would take $1.53 to buy a deutschemark, and only $1.23 to buy a French franc. So from France’s point of view the euro, at say $1.33, is over-valued, while from Germany’s it is undervalued.
European Central Bank head Mario Draghi straddled the Franco-German divide by reminding Hollande that the ECB is independent, and at the same time hinting that if the strong euro reduced the threat of inflation he might ease further, a hint that brought the euro down by about one-cent against the dollar, a bit of cheer for eurozone exporters, but only a tiny bit, prompting them to pressure Draghi for more, please, sir.
Hollande wants to enter what the media are calling the currency wars. Economists prefer the term “competitive devaluations,” one country’s devaluation leading to competitive responses from other nations.
It is not clear, of course, that the road to riches runs through a devaluation of the national currency. Such a move makes imports more expensive, driving up inflation. It also drives up the cost of raw materials bought by domestic manufacturers and eases pressure on them to keep their costs down, since they have less to fear from the now-more-expensive foreign competition. But politicians who play the devaluation game hope that consumers will not notice, witness then-prime minister Harold Wilson’s infamous statement that the 1967 devaluation of the pound only meant that British goods would be cheaper overseas but “It does not mean that the pound here in Britain, in your pocket or purse or in your bank, has been devalued.”
Such hypocrisy is the language of choice of most politicians when it comes to the value of their currencies. “A strong dollar is one of the greatest weapons against inflation” intoned Ronald Reagan—and one year later negotiated a 50 percent devaluation of the dollar—at an international conference at the Plaza Hotel, a deal since known as the Plaza Accord. And presidents ever since have stuck to the line that a strong dollar is in America’s interests, while at the same time proposing export-led growth.
Until now, China has been the world’s devaluer par excellence, keeping the yuan low so that its export-led economy could continue to provide jobs for the millions of Chinese moving off the farms and into the cities. Now, Japan’s new prime minister Shinzo Abe has joined the war, pressuring his central bank to print money and drive down the value of the yen to rescue Japan from “the strengthening yen.” From Mr. Abe’s point of view, so far so good: the yen has fallen about 15 percent against other currencies, making Japanese cars and other products considerably cheaper overseas; the Nikkei share price index is up about 35 percent; and U.S. importers are again ordering Japanese products that they discontinued in the stronger-yen era. The Organization for Economic Co-operation and Development estimates that this currency shock will raise Japan’s GDP (not adjusted for inflation) by 2-3 percent if devaluation stops at this level. And the Financial Times concludes that “it is clear that the 15 per cent tumble in the yen against the US dollar since mid-November has given a lift to the world’s third largest economy.” American manufacturers are understandably less enthusiastic about this development, which faces them with fiercer competition from Asia’s two largest economies.
Brazil, an experienced battler in currency wars, coupled its own devaluation with a plea for the World Trade Organization to permit it to raise tariffs on other devaluers. That idea has been bruited about in America, where leading Democratic politicians want to impose tariffs on made-in-China goods to offset the disadvantage America’s manufacturers face from China’s currency manipulation.
Meanwhile, Britain is about to get a new governor of the Bank of England, Mark Carney, an import from Canada. Carney is unlikely to be a reluctant recruit to the currency war, although like all central bankers he will deny participation. A few days ago Carney told a parliamentary select committee that he will use all tools at hand to revive the British economy, including its export sector, and spoke approvingly of some of the goings-on in the U.S. at the instigation of the Fed. If sterling were to drop after Carney dipped into his tool kit, well, so be it.
It should be obvious that the currency war is a trade war by other means. The use of traditional weapons—tariffs to keep out imports and thereby increase demand for homemade products and create jobs—was outlawed by mutual consent of the warring parties when they agreed to abide by the rules of the World Trade Organization. So a new weapon of trade destruction has been rolled out—the printing press. Run the presses, flood the markets with your currency, and later, if not sooner, your currency will depreciate, giving you an edge in world markets. Until trading partners respond.
The U.S. and the UK, among others, have already deployed that weapon, and the new head of Japan’s central bank is likely to be chosen by Abe from the warrior class. Germany, not overjoyed with Draghi’s hint that he might take up arms, continues to insist that the ECB remain a non-combatant. Angela Merkel has made it clear that the long unpleasantness that followed Germany’s decision to run the money presses overtime in the 1930s is still etched in Germans’ minds, and that she agrees with Vladimir Ilyich Lenin that “the surest way to destroy a nation is to debauch its currency,” a view on which John Maynard Keynes put his stamp of approval: “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”
The difference between these two acute observers is that Lenin would be cheering the currency wars, Keynes bemoaning them.