THE term currency wars has sparked a vigorous debate within the economics commentariat. The term was coined by Brazils then finance minister, Guido Mantega, in 2010 when the real was moving sharply higher, a nice irony given the reals recent falls to record lows. Some saw it as a negative development, talking of beggar-thy-neighbour devaluations designed to grab a bigger share of world trade; eventually, this was a zero sum game since all currencies cannot devalue. The counter-argument was that, on the contrary, this was positive for the world economy. Countries were easing monetary policy, either by cutting interest rates or adopting quantitative easing, and the aggregate effect would be to boost global demand. Parallels were drawn with the 1930s when developed countries abandoned the gold standard and those that devalued first, recovered most quickly.
A new (privately circulated, so no link) note from Stephen King, the senior economic adviser at HSBC, argues that the 1930s parallel is incorrect and that, currently
attempts by individual central banks to boost growth and inflation via currency depreciation have been collectively self-defeating
The key difference, in Mr Kings view is that
In the 1930s, currency declines weren't just simple devaluations. They represented, instead, a seismic change in monetary regimes. The gold standard was abandoned. The anchor that had kept inflation low disappeared overnight. Inflationary expectations were destabilised. In the US, President Roosevelt made it clear that he wanted the price level - at least for commodities - to return to where it had been before the onset of early-1930s deflation.
Put another way, currency devaluations weren't just 'beggar-thy-neighbour' policies: they also helped raise inflation expectations. By implication, real interest rates fell, the burden on debtors was lifted, bankruptcies declined, lending revived and economies recovered.
King looks at nine countries that went off the gold standard in the 1930s; the average inflation rate in the five years before devaluation was -5.4% (ie, deflation). The average inflation rate in the subsequent five years was +5.7%. Australia and Canada, two commodity producers, were the only ones to get stuck in the deflation trap. but the modern round of depreciations, in the UK, euro zone and Japan have had nothing like the same effect; countries are still struggling to generate any kind of inflation. And, of course, without inflation, the nominal burden of high debt levels remains in place.
Nor have devaluations done much to stimulate economic growth. Mr King points out that, in the three years since Shinzo Abe took power in Japan (ushering in Abenomics which involved quantitative easing and a decline in the yen), Japanese growth has averaged 0.8%. That is not better than in the pre-Abe period. The ECB was the latest big central bank to step up its monetary stimulus; this month it cut its growth forecasts for 2016 and 2017.In every year since 2010, world growth has disappointed relative to economic forecasts at the start of the year, by an average of 0.9 percentage points. In the last four years, the BRICs countries (Brazil, Russia, India and China) have also produced growth lower than forecast, by an average of 1.4 percentage points.
So why hasnt it worked? Mr King says that loose monetary policy has failed to stimulate the domestic economy but has given countries a brief export boost. This has allowed companies to remain in business, that might otherwise have gone bust.
That, however, is not much more than a case of robbing Peter to pay Paul - and it leaves the world still suffering from excess capacity, thereby reducing the chances of a sustained increase in capital spending
So Mr King falls into the beggar-thy-neighbour camp, arguing that
In the absence of a major monetary revolution, big movements in currencies are more likely simply to redistribute deflationary pain than create decent economic growth, particularly if nominal interest rates are already at the zero rate bound. Greater policy-induced currency uncertainty may also contribute to unusually weak world trade growth, consistent with the post-financial crisis experience.
Rather than pursue devaluation, Mr King argues that countries should try to improve their productivity records, which have been poor. But that implies pushing through the kind of economic reforms that special interests (and many voters) dislike. Devaluation is the more tempting, and easier, option.