So it is official: there will be no currency war. Yesterday, the G7 finance ministers and central governors stated: “We reaffirm that our fiscal and monetary policies have been, and will remain, oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates.”
If you cut through the officialese, what the G7 was trying to do was to reassure business and markets that there would be no competitive devaluations. That might seem anodyne enough, but the very fact that it should feel the need to do so tells a story. It is one of rising concern that countries were indeed deliberately trying to push down their currencies – Switzerland, Japan, the UK, the US, the eurozone – to try to gain competitive advantage in a world that is short on demand. The folk memory of the 1930s Depression, when there was, indeed, a currency war, started by Britain in 1931 when sterling came off the Gold Standard, lingers still.
But what is really happening? I think the achingly slow recovery from recession has added to the pressures to do anything, including trying to maintain a competitive currency, to get economies moving again. In the case of Switzerland, the franc had become seriously overvalued as money flooded into the country as a safe haven, so getting it down was explicit policy. With the Japanese yen, there was a policy to try to drive it down but that is understandable given its recent strength. Back in 2007, it traded around Y120 to the dollar. For most of last year, it was below Y80, making its present level of Y93 look reasonable enough.
But Switzerland and Japan apart, it is hard to see any overt currency manipulation. Thus, the main thrust in both the US and the UK has been to boost domestic demand by very loose monetary policies. These have had the side effect of holding down sterling and the dollar (rather than that being the primary aim). With the euro, the policy of the European Central Bank has been to support it by promising to buy distressed country debt – which had the side effect of reversing the flight from the euro that reached its height last summer.
Rather than see what is happening as a set of currency skirmishes, I think it is more correct to see currency movements as consequences, welcome or unwelcome, of extreme monetary policies. To try to boost growth, the world’s central banks are using policies previously only used to finance wars. A government needs to borrow. There are not enough savings to finance it. So the central bank buys the debt instead. This used to happen in peacetime, but on a small scale. Now the Bank of England has bought one-third of our National Debt – and we have no idea of how this debt will be sold back to genuine long-term investors, as text-book central banking theory requires should be done.
The key problem with monetary policy is its uncertainty. Take two sterling devaluations, the sudden one in 1992 after we left the Exchange Rate Mechanism and the downward slither in 2008 as recession struck. In both instances, the devaluation was about 20 per cent. But the first led to relatively little inflation, much less than expected, and gave a good boost to exports. By 1997, the current account was just about in balance. This time, exports have benefited hardly at all, and inflation has been much worse than expected.
It would be great to know why but I don’t think we do. As a general comment, I think it is true that the global business community has learnt to live with currency instability by spreading costs and suppliers so that there is a swings-and-roundabouts effect. The flip side of that is that currency stability, for example in the eurozone, has not brought the benefits expected of it. But nor has the devaluation of sterling. So provided that the various monetary authorities behave in a measured, orderly way, then damage should be limited. But the fact that the G7 needs to say there won’t be a war reminds us that we live in a fragile world.