Davos talk of new currency war is wildly exaggerated

Worries about the Bank of Japan's money-printing efforts to breathe inflationary life into the country's economy are highly overblown

PUBLISHED : Monday, 28 January, 2013, 12:00am
UPDATED : Monday, 28 January, 2013, 5:27am

Just as sentiment towards the world's economy and financial markets was perking up, the legion of praters assembled in Davos over the weekend found something else to worry about: the threat of a global currency war.

Their fears are overblown.

Talk of currency wars is nothing new. Politicians from the United States have long accused Beijing of stealing an unfair economic advantage by deliberately holding down the yuan in order to promote Chinese exports abroad while pricing imported goods out of China's domestic market.

In turn Chinese officials complain that the US Federal Reserve's ultra-loose quantitative easing policy is a ploy to debase the US dollar and erode the real value of China's vast holdings of US debt.

This time, however, it is neither China nor the United States at the centre of the global slanging match, but Japan.

In a bid to revitalise the country's ailing economy, the Bank of Japan announced last Tuesday that it would adopt a new policy of inflation targeting - with its desired rate of price increases set at 2 per cent - and said it would embark on an open-ended programme of money-printing in an effort to hit its target.

Analysts at Morgan Stanley called the announcement "a once-in-a-generation policy shift", while delegates at Davos lined up to warn that the BOJ's new policy is a naked attempt to force down the yen and risks triggering a destructive round of competitive devaluations by other major economies.

Hedge fund manager George Soros forecast foreign exchange market "fireworks". German politicians hinted darkly at retaliation. The Organisation for Economic Co-operation and Development cautioned against "beggar-thy-neighbour" policies. The head of the Kuwait Investment Authority feared a wave of devaluations across Asia. And Jin Liqun, supervisory chairman of China's US$482 billion sovereign wealth fund, warned "there will be no winners in a currency war".

In reality, however, the BOJ's move was long expected, turned out barely to alter the central bank's existing policy settings, and is unlikely to provide much of a boost for Japan's stagnant economy.

Certainly the announcement was no surprise. The yen has been weakening against other major currencies for months now as traders and investors exited their long positions in the currency in anticipation that Shinzo Abe would win Japan's December election and institute more aggressive economic policies.

Since the end of September, the yen has fallen 14.3 per cent against the US dollar, 15.4 per cent against the yuan and 17.5 per cent against both the euro and the South Korean won.

But these falls only partly undo the yen's massive overvaluation, after the currency's trade-weighted value climbed 45 per cent between 2008 and 2012 (see the first chart), pushing export-powerhouse Japan into a trade deficit last year.

Nor does the BOJ's announcement represent much of a policy change. Its new 2 per cent inflation target replaces its previous "goal" of 1 per cent inflation, a level that in the last 12 years it only hit during the 2008 commodity price bubble (see the second chart).

As for printing money, the BOJ has been doing that for 10 years now, buying government debt from Japan's banks.

Its new open-ended commitment sounds impressive. But with only modest provisional purchase targets and a focus on buying shorter-dated debt maturities, the new policy might turn out to be even less effective than the BOJ's previous programme of asset purchases.

As a result, all the talk over the weekend that the BOJ's new monetary stance might trigger a devastating international currency war sounds decidedly overblown.

Still, it gave the Davos blowhards something else to sound off about.