The Japanese Finance Minister, Sadakazu Tanigaki, was as inscrutable as ever at a news conference yesterday, but currency traders don't need Ministry of Finance confirmation to know the truth of the matter: last week the Japanese authorities again set a new record in the amount they've been spending on currency intervention. In so doing, they managed to depress the yen to a five-month low against the US dollar, in marked contrast to the euro, which was again on the rise against the greenback following Friday's disappointing US jobs data.
Even in dollar terms, let alone yen, the amounts being thrown with apparent abandon by the Japan Ministry of Finance at keeping the yen low against the dollar have reached mindboggling proportions. Last year, Japan spent $175bn selling yen and buying dollars. In January, a new monthly record of $67bn was set and, by the look of it, the figure for March may be higher still. Think back to the great currency plays of the past, and nothing comes remotely close to the now daily routine of Asian central bank currency intervention.
For it is not just Japan which is trying to keep its currency down. China is spending a similar order of magnitude to maintain its currency peg against the dollar. From India to Korea, central banks around the region have felt compelled to join the party. India's reserves of foreign currency alone have risen from $40bn to $100bn over the past 18 months. China now has some of the largest reserves of dollar assets in the world.
Yet it is not for the purpose of accumulating dollar assets that Asia is selling its own currencies and buying dollars. Rather the purpose is to keep the currencies low, thereby improving the competitiveness of local industry, which in turn is helping to underpin strong economic growth. Portfolio accumulation is a by product of a process meant primarily as a direct public subsidy to Asian industry.
In Japan, currency intervention is seen as key to sustained economic recovery. Even a small uplift in the currency might cause the present recovery in corporate profits to stall, which would in turn interfere with the rebound in business investment. Japan's success as an exporter is critical to its economic success more generally.
Intervention on the scale being applied by the big Asian economies seems on the face of it a highly dangerous phenomenon. What's the exit strategy, and does it really make economic sense to spend so much public money buying overseas debt (the money is mainly spent on US Treasury bonds)? The answer depends crucially on how the intervention is managed. In Japan, nearly all intervention is "sterilised". Yen created to buy dollars is taken back out of the domestic economy by selling an equal and opposite amount of government bonds and bills. Assuming the process is being carried out as claimed, the effect on the money supply is therefore neutral with no inflationary consequences.
As it happens, Japan's deflationary economy makes its sterilisation of currency intervention unnecessary. With interest rates at close to zero, the extra money supply that would be created by un-sterilised intervention is unlikely to make any difference to the domestic economy. Through other mechanisms, the Bank of Japan has added 30 per cent to Japan's base of money over the past year, but it's had virtually no impact on wider money supply, if only because the banks find it virtually impossible to on lend the new money into the Japanese economy. Deflation means there's little demand for it.
However, in less developed areas of Asia, particularly China and India, where government debt markets are not sufficiently developed to allow for full sterilisation of currency intervention, the process is already proving inflationary. Even in Japan, it might eventually become so if deflationary pressures ease.
Yet the real long-term damage of intervention on this scale is that it distorts the natural balance of the capital markets and thereby creates disequilibrium in world trade and economic activity. This is a lot easier to justify in the developing economies of China and India, where it seems only right and proper that the playing field be tipped in their favour, than it is with Japan, an already developed and prosperous economy.
Japan's expenditure on foreign exchange intervention roughly equals the size of its current account surplus plus the amount of foreign capital flowing into its equity markets. The two capital flows offset each other. Broadly speaking, the yen that are bought by foreigners buying Japanese goods and equities are cancelled out by the yen that are sold by the Bank of Japan in currency intervention. What's wrong with that?
What's wrong is that the currency would normally adjust to bring the balance of trade back into equilibrium. Plainly that's not happening with the Asian economies. If trade gets out of balance, that creates political pressure for protectionism, from which everyone eventually loses. Asian currency intervention is thus becoming a danger to free trade, and to the process of efficient allocation of capital that lies at the heart of the free trade process.
For the time being, US policymakers don't seem to care. Asian central bank intervention finances their own current account deficit and helps keep US interest rates lower than they would be otherwise. So everyone's a winner? Not quite. The biggest losers are the Europeans, and increasingly Britain too, whose currency has come to move in tandem with the euro. As Britain's record trade deficit for January demonstrates, it's no laughing matter.
Unlike almost everywhere else, interest rates in Britain are rising in an effort to choke off the consumer and mortgage credit boom, so the upward pressure on the currency can only get worse. The way things are going, the Treasury will soon be taking a leaf out of the Japanese Ministry of Finance's book. It's an awfully long time since Britain last tried to depress the value of its currency through intervention. The policy imperative in post war Britain has always been to support it. Time, perhaps, for a change of tack.
The Adam Smith Institute is broadly on message with other think-tanks and policy wonks with today's little pamphlet urging that the Government dramatically increases the basic state pension over time. Yet it's numbers don't anywhere near stack up. The problem with Britain's state pension is that although it is affordable for the public finances, it is also insufficient to live on, with the result that those who don't make private pension provision are forced to fall back on other forms of state benefit to keep body and soul together.
With the passage of time, that situation can only get worse, as the basic state pension is indexed to inflation, not earnings. This creates a lag effect that will reduce average state retirement benefit from about 18 per cent of average earnings today to less than 10 per cent by 2050. In an article by Alan Pickering, a partner at Watson Wyatt, the Adam Smith Institute proposes a new universally available pension equal to 40 per cent of average earnings. This would provide the living wage lacking in the present system. It would also allow for the dismantling of the legion of stifling rules and regulations that surround private pension provision, as private pensions would no longer need to be regulated for welfare purposes.
So far so good, but how to pay for such generous state provision? Simply by raising the retirement age to between 68 and 70, suggests the Institute. Er, I don't think so. True, this would generate savings, but not of a size anywhere near big enough to pay for pensions equal to 40 per cent of earnings in an ageing population where longevity is improving all the time.
The institute suggests further savings could be generated by abolishing tax relief on private pension provision, which at present disproportionately benefits higher earners. Yet even this would be insufficient to bridge the gap. Politically, it would in any case be difficult to raise the age at which retirees would qualify for state pension benefits, as those in low paid, manual work tend to live fewer years in retirement than more middle class citizens. The Adam Smith Institute is thinking along the right lines, but its arithmetic needs more work.Reuse content