The Dollar Joins the Currency Wars
NEW YORK – In a world
of weak domestic demand in many advanced economies and emerging
markets, policymakers have been tempted to boost economic growth and
employment by going for export led-growth. This requires a weak currency
and conventional and unconventional monetary policies to bring about
the required depreciation.
Since the beginning
of the year, more than 20 central banks around the world have eased
monetary policy, following the lead of the European Central Bank and the
Bank of Japan. In the eurozone, countries on the periphery needed
currency weakness to reduce their external deficits and jump-start
growth. But the euro weakness triggered by quantitative easing has
further boosted Germany’s current-account surplus, which was already a
whopping 8% of GDP last year. With external surpluses also rising in
other countries of the eurozone core, the monetary union’s overall
imbalance is large and growing.
In Japan,
quantitative easing was the first “arrow” of “Abenomics,” Prime Minister
Shinzo Abe’s reform program. Its launch has sharply weakened the yen
and is now leading to rising trade surpluses.
The upward pressure
on the US dollar from the embrace of quantitative easing by the ECB and
the BOJ has been sharp. The dollar has also strengthened against the
currencies of advanced-country commodity exporters, like Australia and
Canada, and those of many emerging markets. For these countries, falling
oil and commodity prices have triggered currency depreciations that are
helping to shield growth and jobs from the effects of lower exports.
The dollar has also
risen relative to currencies of emerging markets with economic and
financial fragilities: twin fiscal and current-account deficits, rising
inflation and slowing growth, large stocks of domestic and foreign debt,
and political instability. Even China briefly allowed its currency to
weaken against the dollar last year, and slowing output growth may tempt
the government to let the renminbi weaken even more. Meanwhile, the
trade surplus is rising again, in part because China is dumping its
excess supply of goods – such as steel – in global markets.
Until recently, US
policymakers were not overly concerned about the dollar’s strength,
because America’s growth prospects were stronger than in Europe and
Japan. Indeed, at the beginning of the year, there was hope that US
domestic demand would be strong enough this year to support GDP growth
of close to 3%, despite the stronger dollar. Lower oil prices and job
creation, it was thought, would boost disposable income and consumption.
Capital spending (outside the energy sector) and residential investment
would strengthen as growth accelerated.
But things look
different today, and US officials’ exchange-rate jitters are becoming
increasingly pronounced. The dollar appreciated much faster than anyone
expected; and, as data for the first quarter of 2015 suggest, the impact
on net exports, inflation, and growth has been larger and more rapid
than that implied by policymakers’ statistical models. Moreover, strong
domestic demand has failed to materialize; consumption growth was weak
in the first quarter, and capital spending and residential investment
were even weaker.
As a result, the US has effectively joined the "currency war" to prevent further dollar appreciation. Fed officials have started to
speak explicitly about the dollar as a factor that affects net exports,
inflation, and growth. And the US authorities have become increasingly
critical of Germany and the eurozone for adopting policies that weaken
the euro while avoiding those – for example, temporary fiscal stimulus
and faster wage growth – that boost domestic demand.
Moreover,
verbal intervention will be followed by policy action, because slower
growth and low inflation – partly triggered by a strong dollar – will
induce the Fed to exit zero policy rates later and more slowly than
expected. That will reverse some of the dollar’s recent gains and shield
growth and inflation from downside risks.
Currency frictions
can lead eventually to trade frictions, and currency wars can lead to
trade wars. And that could spell trouble for the US as it tries to
conclude the mega-regional Trans-Pacific Partnership.
Uncertainty about whether the Obama administration can marshal enough
votes in Congress to ratify the TPP has now been compounded by proposed
legislation that would impose 'tariff duties'
on countries that engage in “currency manipulation.” If such a link
between trade and currency policy were forced into the TPP, the Asian
participants would refuse to join.
The world would be
better off if most governments pursued policies that boosted growth
through domestic demand, rather than beggar-thy-neighbor export
measures. But that would require them to rely less on monetary policy
and more on appropriate fiscal policies (such as higher spending on
productive infrastructure). Even income policies that lift wages, and
hence labor income and consumption, are a better source of domestic
growth than currency depreciations (which depress real wages).
The sum of all trade
balances in the world is equal to zero, which means that not all
countries can be net exporters – and that currency wars end up being
zero-sum games. That is why America’s entry into the fray was only a
matter of time.
Nouriel Roubini
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