The main talking point in the foreign exchange market since the start of the year has been the escalation in rhetoric from policymakers around the globe about the value of their currencies. That has sparked a wave of speculation that the world is about to see the eruption of a currency war, a prospect that has the potential to destroy the global economic recovery. For now, however, such a scenario seems remote.
Still, faced with fragile growth, more countries are intervening, both verbally and physically, or imposing capital controls in a bid to boost their economies. In short, nations are using their currency as a policy tool.
That trend has been noted among policymakers, with Mervyn King, governor of the Bank of England, expressing concerns “we may now see the growth of actively managed exchange rates as an alternative to the use of domestic monetary policy”.
In other words, as Maurice Pomery, chief executive officerat research firm Strategic Alpha, points out, conventional monetary policy tools have reached the limit of their effectiveness.
“It is abundantly clear that many an exporter out there sees their currency as a policy tool now to improve export numbers and maintain competitiveness,” he says.
“However, currencies all trade against one another and thus there will be losers in this and tensions are sure to rise.”
Those tensions are certainly on the rise, with Japan singled out as the main culprit. Indeed, many see Tokyo as the catalyst for the renewed currency war hostilities.
The yen is down more than 15% against the euro and is more than 10% weaker against the dollar since Japanese prime minister Shinzo Abe began to talk down his currency ahead of his return to power in December.
Abe has repeatedly reiterated his view that the biggest problem Japan faces is deflation and a strong currency, piling pressure on the Bank of Japan to engage in unlimited quantitative easing in a bid to boost the Japanese economy.
That has shifted the goalposts in the currency wars arena, which traditionally has been the preserve of emerging market nations, concerned that ultra-loose monetary policy in the developed world was driving overvaluation in their currencies.
Since Japan’s policy shift, there have been reactions from developed nations as well as its trading partners.
In Europe – where Switzerland has been a fully paid up member of the currency war club since it introduced a floor in the value of the euro against the Swiss franc in September 2011, to protect its export sector from what it termed as excessive strength in its currency – Norway and Sweden have voiced concern over currency strength in recent weeks.
Meanwhile, Korea, which has seen the won rise by more than 20% against the yen since the middle of last year, appears to be losing patience with its currency strength. Bahk Jae-wan, Korea’s finance minister, maintains the market should set exchange rates in line with economic fundamentals, but warns that his government “could expand its range of macro prudential measures if necessary to prevent speculators from driving the won’s value”.
Russia, which hosts next month’s meeting of G20 finance ministers and central bank governors in Moscow, has also raised concerns, with Alexei Ulyukayev, first deputy chairman of the country’s central bank, warning that other countries might follow Japan’s lead.
Certainly, Japan’s shift will give the G20 plenty to mull over. After all, the communiqué after its last meeting in Mexico City in November reiterated the group’s commitment to move rapidly toward more market-determined exchange rate systems and exchange rate flexibility “to reflect underlying fundamentals, avoid persistent exchange rate misalignments and refrain from competitive devaluation of currencies”.
There has been no progress there, let alone anything resembling rapid.
For investors, the prospect of a currency war is a problem. Weakening your currency is a form of protectionism that is bad for the global economy. It promotes inefficiencies and in the extreme could trigger trade sanctions that have the potential to strangle economic growth.
However, for all the banner headlines over currency wars, currency managers take a sanguine view about the prospect of a full-blown conflict.
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| Thanos Papasavvas, head of currency management at Investec Asset Management |
Thanos Papasavvas, head of currency management at Investec Asset Management, says after a positive start to the year, central banks might soon start allowing or accepting modest currency appreciation as inflationary pressures creep higher. He certainly does not foresee an escalation in currency tensions that could provoke trade disputes.
“It is no one’s interest to do that,” says Papasavvas. “The whole concept of currency wars is overplayed."
Papasavvas believes if the world moves on to the next stage of the cycle in which economies have stabilized, and the Federal Reserve starts preparing the market for an eventual exit from ultra-easy monetary policy, central banks around the world will be more comfortable with stronger currencies.
A stronger currency, he says, will help contain inflationary pressures coming in from abroad and it means central banks, particularly in emerging markets, will not have to raise interest rates domestically to fight inflation.
“If we are seeing the beginnings of stability and the turnaround to the next stage of the cycle, central banks in those regions will be comfortable to see some currency strength,” says Papasavvas. “The currency can do some of the work for them.”
Papasavvas holds core short dollar and yen positions, and is positioned long of emerging market currencies, on the basis that the global economy is turning the corner.
Ken Dickson, currency investment director at Standard Life Investments, is also positioned short of the yen and does not see the recent move in the currency as a reason to worry over an upsurge in protectionism.
As a longer-term investment manager, with a two- to three-year time horizon, Dickson says nations’ currency policy is something that drives his decision-making.