Currency Wars: The Next Generation

I saw an interesting news story on the Bloomberg website today. The title sums it up pretty well. “Currency Wars Evolve With Goal of Avoiding Deflation.” Just as Lars Christensen predicted recently, nervous — and misguided — talk about currency wars is spreading fast. Here’s what it says on Bloomberg:

Currency wars are back, though this time the goal is to steal inflation, not growth.

Brazil Finance Minister Guido Mantega popularized the term “currency war” in 2010 to describe policies employed at the time by major central banks to boost the competitiveness of their economies through weaker currencies. Now, many see lower exchange rates as a way to avoid crippling deflation.

Now, as I have pointed out many times (e.g., here, here, and most recently here), “currency war” in the sense used by Mantega, also known as “currency manipulation” or “exchange-rate protection” involves the simultaneous application of exchange-rate intervention by the monetary authority to reduce the nominal exchange rate together with a tight monetary policy aimed at creating a chronic domestic excess demand for money, thereby forcing domestic households and businesses to restrict expenditure to build up their holdings of cash to desired levels, resulting in a chronic balance of payments surplus and the steady accumulation of foreign-exchange reserves by the central bank. So the idea that quantitative easing had anything to do with “currency war” in this sense was a nonsensical notion based on a complete failure to understand the difference between a nominal and a real exchange rate.

“This beggar-thy-neighbor policy is not about rebalancing, not about growth,” David Bloom, the global head of currency strategy at London-based HSBC Holdings Plc, which does business in 74 countries and territories, said in an Oct. 17 interview. “This is about deflation, exporting your deflationary problems to someone else.”

Bloom puts it in these terms because, when one jurisdiction weakens its exchange rate, another’s gets stronger, making imported goods cheaper. Deflation is a both a consequence of, and contributor to, the global economic slowdown that’s pushing the euro region closer to recession and reducing demand for exports from countries such as China and New Zealand.

Well, by definition of an exchange rate (a reciprocal relationship) between two currencies, if one currency appreciates the other depreciates correspondingly. If the euro depreciates relative to the dollar, prices of the same goods will rise measured in euros and fall measured in dollars. The question is what has been causing the euro to depreciate relative to the dollar. The notion of a currency war is meaningless if the change in exchange rates is not at least in part being driven by a deliberate policy choice. So what kind of policy choices are we talking about?

Bank of Japan Governor Haruhiko Kuroda said last month he’d welcome a lower exchange rate to help meet his inflation target and may extend the nation’s unprecedented stimulus program to achieve that. Like his Japanese counterpart, European Central Bank President Mario Draghi has acknowledged the need for a weaker euro to avoid deflation and make exports more competitive, though he’s denied targeting the exchange rate specifically.

After the Argentine peso, which is plunging following a debt default and devaluation, the yen will be the biggest loser among major currencies by the end of 2015, according to median strategist forecasts compiled by Bloomberg as of yesterday. A 6 percent decline is predicted, which would build on a 5.5 percent slide since June.

The euro is also expected to be among the 10 biggest losers, with strategists seeing a 4.8 percent drop. The yen traded at 107.21 per dollar 10:18 a.m. in New York, while the euro bought $1.2658.

Notice that there is no mention of the monetary policy that goes along with the exchange-rate target. Since the goal of the monetary policy is to produce inflation, one would imagine that the mechanism is monetary expansion. If the Japanese and the Europeans want their currencies to depreciate against the dollar, they can intervene in foreign-exchange markets and buy up dollars with newly printed euros or yen. That would tend to cause euros and yen to depreciate against the dollar, but would also tend to raise prices of goods in terms of euros and yen. How does that export deflation to the US?

At 0.3 percent in September, annual inflation in the 18-nation bloc remains a fraction of the ECB’s target of just under 2 percent. Gross-domestic-product growth flat-lined in the second quarter, while Germany, Europe‘s biggest economy, reduced its 2014 expansion forecast this month to 1.2 percent from 1.8 percent.

Disinflationary pressures in the euro area are starting to spread to its neighbors and biggest trading partners. The currencies of Switzerland, Hungary (HUCPIYY), Denmark, the Czech Republic and Sweden are forecast to fall from 3.8 percent to more than 6 percent by the end of next year, estimates compiled by Bloomberg show, partly due to policy makers’ actions to stoke prices.

“Deflation is spilling over to central and eastern Europe,” Simon Quijano-Evans, the London-based head of emerging-markets research at Commerzbank AG, said yesterday by phone. “Weaker exchange rates will help” them tackle the issue, he said.

Hungary and Switzerland entered deflation in the past two months, while Swedish central-bank Deputy Governor Per Jansson last week blamed his country’s falling prices partly on rate cuts the ECB used to boost its own inflation. A policy response may be necessary, he warned.

If the Swedish central bank thinks that it is experiencing deflation, it has tools with which to prevent deflation from occurring. It is bizarre to suggest that a rate cut by ECB could be causing deflation in Sweden.

While not strictly speaking stimulus measures, the Swiss, Danish and Czech currency pegs — whether official or unofficial — have a similar effect by limiting gains versus the euro.

The Swedes could very easily adopt a similar currency peg to avoid any appreciation of the Swedish krona against the euro.

Measures like these are necessary because, even after a broad-based dollar rally, eight of the Group of 10 developed-nation currencies remain overvalued versus the dollar, according to a purchasing-power parity measure from the Organization for Economic Cooperation & Development.

If these currencies are overvalued relative to the dollar, according to a PPP measure, they are under deflationary pressure even at current exchange rates. That means that exchange rate depreciation via monetary expansion is essential to counteracting deflationary pressure.

The notion that exchange-rate depreciation to avoid deflation is a beggar-thy-neighbor policy or a warlike act could not be more wrong. If exchange-rate depreciation by one country causes retaliation by other countries that try to depreciate their currencies even more, that would be a virtuous cycle, not a vicious one.

In his book Trade Depression and the Way Out, Hawtrey summed it up beautifully over 80 years ago, as I observed in this post.

In consequence of the competitive advantage gained by a country’s manufacturers from a depreciation of its currency, any such depreciation is only too likely to meet with recriminations and even retaliation from its competitors. . . . Fears are even expressed that if one country starts depreciation, and others follow suit, there may result “a competitive depreciation” to which no end can be seen.

This competitive depreciation is an entirely imaginary danger. The benefit that a country derives from the depreciation of its currency is in the rise of its price level relative to its wage level, and does not depend on its competitive advantage. If other countries depreciate their currencies, its competitive advantage is destroyed, but the advantage of the price level remains both to it and to them. They in turn may carry the depreciation further, and gain a competitive advantage. But this race in depreciation reaches a natural limit when the fall in wages and in the prices of manufactured goods in terms of gold has gone so far in all the countries concerned as to regain the normal relation with the prices of primary products. When that occurs, the depression is over, and industry is everywhere remunerative and fully employed. Any countries that lag behind in the race will suffer from unemployment in their manufacturing industry. But the remedy lies in their own hands; all they have to do is to depreciate their currencies to the extent necessary to make the price level remunerative to their industry. Their tardiness does not benefit their competitors, once these latter are employed up to capacity. Indeed, if the countries that hang back are an important part of the world’s economic system, the result must be to leave the disparity of price levels partly uncorrected, with undesirable consequences to everybody. . . .

The picture of an endless competition in currency depreciation is completely misleading. The race of depreciation is towards a definite goal; it is a competitive return to equilibrium. The situation is like that of a fishing fleet threatened with a storm; no harm is done if their return to a harbor of refuge is “competitive.” Let them race; the sooner they get there the better.

The only small quibble that I have with Hawtrey’s discussion is his assertion that a fall in the real wage is necessary to restore equilibrium. A temporary fall in real wages may be part of the transition to equilibrium, but that doesn’t mean that the real wage at the end of the transition must be less than it was at the start of the process.


18 Responses to “Currency Wars: The Next Generation”

  1. 1 roger erickson October 23, 2014 at 6:37 am

    Always Remember That Floating Fx Reflects Policy Steps, Not Just Markets Presumed To Function In Isolation

    Naïveté = uncertainty.

    There is no such thing as Free Trade. There are only policies affecting arbitrage opportunities for different people, disciplines and whole classes of citizens.

    Statesmanship means trying to track the long-term implications of policy for national options. Politicians are hired to NOT paint their electorates into corners which the people on the street can’t possibly see coming.


  2. 2 Benjamin Cole October 23, 2014 at 8:44 pm

    Like I have been saying since 2008: Put the money printing presses on “Danger Red Zone High” and lock the doors. Egads, how obvious is this?

    People tsk-tsked me.

    But is this better now? Deflation in Japan, on the way in Europe, and the US in perma “new normal” soggy real income gains, in any.

    There are about many people working now as in 2007, in the USA. They call this a recovery.

    Egads, are microscopic inflation rates so attractive as to forego prosperity?


  3. 3 David Glasner October 24, 2014 at 7:27 am

    Roger, I think everyone would agree that floating exchange rates reflect policy steps and even anticipated policy steps. Free trade is an abstract principle about policy-making. In practice, there are many exceptions to it, some reasonable and some not so reasonable.

    Benjamin, Just curious, do you think Obama would be more or less popular than he is now if we had 5% inflation and a million more people employed?


  4. 4 Frank Restly October 24, 2014 at 8:58 am


    “Egads, are microscopic inflation rates so attractive as to forego prosperity?”

    Why do you believe that microscopic inflation rates and prosperity are mutually exclusive?


  5. 5 roger erickson October 24, 2014 at 9:09 am

    Everyone? I’d bet $ that about 90% of the electorate has no idea what you’re talking about. Just try to poll J&J 6pack.


  6. 6 David Glasner October 24, 2014 at 9:35 am

    Roger, I guess I was getting a bit carried away. I meant everyone who knows what it means for exchange rates to float or to be fixed.


  7. 7 am October 27, 2014 at 4:00 am

    I have seem two reference to devaluations in recent weeks on the blogosphere.

    1. A devaluation by the US to achieve full employment. The idea seems to be that the US trade deficit is costing jobs in the USA. By devaluing their exports would increase, imports decrease and the increase in domestic production would result in increase domestic employment in the USA. This is a go it alone approach not related to point 2.

    2. International devaluations to inflate the world economy. Instead of go it alone everyone goes together or chases after each other when one beings the devaluation race. But the idea is that deflation can be avoided by devaluation in a controlled and coordinated process. Deflation or low disinflation is replaced by inflation.

    My points on the above and the post are:

    1. Is today similar to Hawtrey’s time when money was linked to the gold standard. We do not have a gold standard today; just currencies related to each other by some idea of their respective values.

    2. What would 2. above do to interest rates and the general rules of operation under which central banks operate and are constrained, often by legislation.

    I am not an economist but see the political economy as not conducive to this idea of coordinated devaluation. Also I am struggling to see how it will not result in another depression. Perhaps you can give some tips.


  8. 8 roger erickson October 27, 2014 at 6:13 am

    That’s the well-known “Bill Black Conundrum,” stated in a quip 5 years ago.

    It went something like this:

    “Neo-Liberal success will be achieved when all nations are net-exporters, and everyone’s Fx-rate is above normal.” 😦

    That’s been the policy ever since in Swamp Webegoners, since too few got the joke, and it ended up on us.

    ps: If war is too important to leave to the Generals, surely political-economy is too important to be left to economists? In fact, EVERY process is too important to be left to the presumed process owners! That is, after all, the definition of a system. No cross-talk, no coordination, and no group-intelligence. You only have to get to 2nd grade to figure that out.


  9. 9 am October 27, 2014 at 9:53 am

    My question was directed to the blogger but I will say thanks for your answer, although I will still wait for his. I will try to find out who Bill Black is. Never heard of him. He must be an American economic comedian and sounds funny.

    And here is what I found out by google on bill black conundrum.

    I was shocked to see the author of the comment. Now that was creepy.


  10. 10 roger erickson October 27, 2014 at 10:18 am

    no need to feel creepy

    the bill black quote is accurately paraphrased;
    i’ve just called it the Bill Black Conundrum for ~5 years now


  11. 11 am October 27, 2014 at 10:47 am

    Thanks. I see that he is an economics and law professor and obviously of the highest integrity.

    I found this which confirms his ethics:

    On further searches I got this on the economics conundrum:

    You seem to mention it everywhere but it is not in wiki or anywhere else. Perhaps you should write a post about it in your economics blog.


  12. 12 David Glasner October 27, 2014 at 10:57 am

    am, I think that the source of confusion is that the distinction between the real and the nominal exchange rate is not being attended to. A devaluation reduces a countries nominal exchange rate. But if, as a result of devaluation, all prices and wage changed correspondingly the real exchange rate would not change at all. So for a country to get any competitive advantage out of a devaluation, i.e., to reduce its real as well as its nominal exchange rate, it must be the case that prices do not fully adjust to the reduced nominal exchange rate. The usual assumption is that prices to adjust to a change in the exchange rate, though the adjustment can often be sluggish. One of the ways in which the adjustment can be slowed down or prevented is to combine a devaluation with a tight monetary policy. This what what Max Corden called exchange-rate protection, and is now often called currency manipulation, though the latter term is frequently and ignorantly used to apply to any exchange rate policy of which the commentator disapproves.

    What Hawtrey was proposing was using devaluation as a strategy for raising the price level. If the whole point of the devaluation is to raise the price level by a corresponding amount, then it is obvious that there is no intention of altering the real exchange rate. If the real exchange rate is not affected, then trade flows will not be affected except insofar as the increase in the price level stimulates the domestic economy and thereby raises the domestic demand for imports and reducing the export of domestic goods that are purchased at home instead of being exported. That implies an increase in demand for the rest of the world.

    So your option 1 is not a go it alone policy it is a policy that is beneficial to the home economy and to the rest of the world. The more countries that adopt it, the better for all concerned. That is exactly the point from the quotation from Trade Depression the Way Out. I don’t think that it matters whether there is a gold standard or not, the same logic out to apply.


  13. 13 am October 27, 2014 at 11:34 am

    Thanks for putting the time in to give a very full answer. I’ll try and see if I can follow it. Sticky prices and wages was a problem in it all to me. Option 1 was by Dean Baker on his blog and seemed to be a go it alone solution for the benefit of the US and I hope that I am not misrepresenting his position. Option 2 has been mentioned by various commentators as you indicate in the first paragraph of the post above.


  14. 14 Frank Restly October 27, 2014 at 11:57 am


    Is this what you are referring to by a real exchange rate?

    The nominal exchange rate is 50 dollars per peso (picking a number out of thin air). I can give someone 50 dollars for a peso or a peso for 50 dollars not including transaction costs.

    The price level of apples is 100 dollars or 10 pesos per apple. The real exchange rate is the price of apples in dollars (100 per apple) divided by the price of apples in pesos (10 per apple) = 10 dollars per peso. 10 dollars buys the same quantity of real goods (apples) as 1 peso.

    “The usual assumption is that prices to adjust to a change in the exchange rate, though the adjustment can often be sluggish. One of the ways in which the adjustment can be slowed down or prevented is to combine a devaluation with a tight monetary policy.”

    What you are trying to do (I believe) is to prevent an arbitrage opportunity from being exploited. Assuming that both the dollar and peso central bank lend money at a nominal interest rate (they do not demand that loans are repaid in apples), then monetary policy will in no way slow the adjustment.


  15. 15 Benjamin Cole October 28, 2014 at 10:11 pm


    If you are still reading, I think your question is a bit unfairly framed. No, a million more workers would hardly matter in a huge labor force like the US, but people would notice 5% inflation.

    However, generating inflation may be “harder” than we think in the modern economy, with global supply lines. This economy is not inflation-prone anymore. Unions are dead, transportation and telecommunications have been deregged, MTRs are lower, Big Steel, Big Labor, Big Auto and Big Retailers all dead. The Wal-mart import-a-rama model is the new norm. Global supply lines.

    To get to 5% inflation we would probably have to repeat the 1976-1979 US economy performance—a 20% real increase in output. Hard to believe, that was the Carter years. Even that might not get to 5% inflation.


  16. 16 David Glasner October 29, 2014 at 8:14 pm

    Benjamin, Sorry if I was unfair, I wasn’t trying to be. I was just curious how you thought the politics would play out if Obama had supported an inflationary policy. Let me put it to you this way, suppose we had 5% inflation for the last 4 years, how much would unemployment have had to fall for Obama’s approval rating to be above 50%? Your citation of Jimmy Carter as a role model doesn’t make me confident that Obama would be more popular now than Carter was in 1980.


  17. 17 Frank Restly October 30, 2014 at 1:18 pm


    “However, generating inflation may be harder than we think in the modern economy, with global supply lines.”

    Not really. Remember that the Bureau of Labor Statistics has repeatedly changed its inflation metric (CPI) with the end result of lowering the stated inflation rate.

    If you want the CPI to reflect a higher inflation rate, the solution is simple – put housing prices back in (eliminate 1983 substitution of owner’s equivalent rent) and remove hedonic adjustments (eliminate 1995 Boskin commission recommendations).


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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