 |
| Sanjay Mathur, Managing Director & Head of Economics Research, Asia Pacific ex-Japan |
Japan’s new leaders have increased pressure on the country’s central bank to loosen monetary policy to such an extent that it has sparked fears of global competitive devaluations, or currency wars. I believe these fears are steeped in political posturing, rather than economic reality, and that any managed depreciations by central banks will only be effective in the short term. The global reaction to the Bank of Japan’s decision to fight deflation by adopting a 2 per cent inflation target and shifting to ‘open-ended’ asset buying has been loud and clear. Policy makers from South Korea to Germany to Brazil have viewed this depreciation as a competitive devaluation.
The yen has dropped 17 per cent against the dollar since November 2012 and fears of a currency war between central banks have risen sharply.
Japan’s moves have perhaps rattled central banks in Asia more acutely because they come after the expansion of the Federal Reserve’s and the European Central Bank’s (ECB) balance sheets over the past two years. Based on recent announcements, the expansion of the Bank of Japan’s balance sheet in fact looks to be larger that that of the Fed or the ECB. In response, the Philippines and Thailand have threatened to introduce their own capital controls.
But would capital controls or currency devaluations by other central banks actually help a country’s competitiveness in the long term? Looking behind the headlines and the political manoeuvring to the economic reality, the answer is no.
First, other Asian currencies in non-Japan Asia remain competitive against the yen. The Bloomberg-JP Morgan Asia Currency Index (ADXY) shows the yen is still relatively strong against other Asian currencies. It was weaker in the period running to the global financial crisis, 2013 and for much of the time since. Asian exports excluding Japan have been weak, but that is because global demand has been weak, rather than because of encroachment by Japan.
The Asian region has also made substantial productivity gains against Japan. For the most part, since 2011, manufacturing sector productivity growth in ex-Japan Asia has outperformed that in Japan. The country has also been losing market share in global exports, even prior to the global financial crisis, when the value of the yen was more competitive. During this period, exports did not rise proportionately for all ex-Japan Asia economies, but this can be attributed to an ongoing loss in competitiveness against China.
A final point for Asia is that regional production chains have changed over the last decade. Several of the region’s economies have established regional production networks by specialising in intermediate products. According to estimates by the International Monetary Fund (IMF), the share of total Asian exports that were intra-regional rose from 45 per cent to 55 per cent between 2000 and 2009. Of this increase, intermediate exports accounted for about 70 per cent.
This shows that a depreciation of a single economy does not necessarily raise competitiveness – the higher import costs of intermediate products can raise manufacturing costs. The IMF also appropriately concluded that gains from regional devaluation can be more beneficial than those from the devaluation of individual currencies.
That said, capital controls in Asia cannot be ruled out. In the short term, such controls could be effective, both because of a genuine slowdown in currency flows and because of the fear they bring into financial markets. The recent weakness in the Korean won is an example of this fear psychosis. The Thai baht and Philippine peso may also feel this pressure.
Over the longer term, however, capital controls are not likely to reverse medium-term upward pressures on currencies.
This is because the dominant source of appreciation pressure on most currencies has been the current account surplus and not debt portfolio capital, the principal target of capital controls. Though current account surpluses have fallen in most economies, they remain the largest component of the balance of payments. Thailand is an exception in the probable set of countries that could impose controls, but even so, Thailand’s balance of payments has been bolstered by foreign direct investment and this is not the target of capital controls.
Outside Asia, the consumption-driven US economy is unlikely to feel any threat from Japan’s actions. It may make Japanese imports less expensive and in turn help lift consumption in the US economy.
Europe is different, as it could benefit from a weaker euro. Domestic demand in Europe is weak because of fiscal austerity, so the region’s reliance on exports is greater. That makes a competitive euro important.
European policy makers will no doubt continue to oppose Japanese monetary policy, but are unlikely to take further action so long as the currency markets – rather than Japan’s central bank – dictate the strength of yen. If this changes, then it could open up the possibility of tariffs on Japanese imports into the eurozone or other punitive measures.
It is one thing for developing countries to engage in currency wars, but when the developed world does it, it sets a bad precedent and creates the potential for tit-for-tat actions. From crisis, we could move to protectionism. In the long term, that could destabilise an already precarious economic recovery.
For more RBS Insight content, click here
Disclaimer
The contents of this document are indicative and are subject to change without notice. This document is intended for your sole use on the basis that before entering into this, and/or any related transaction, you will ensure that you fully understand the potential risks and return of this, and/or any related transaction and determine it is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances. You should consult with such advisers as you deem necessary to assist you in making these determinations. The Royal Bank of Scotland plc, The Royal Bank of Scotland N.V or an affiliated entity ("RBS") will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser or owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on RBS for investment advice or recommendations of any sort. RBS makes no representations or warranties with respect to the information and disclaims all liability for any use you or your advisers make of the contents of this document. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not lawfully be disclaimed. RBS and its affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding, or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein.
RBS is authorised and regulated in the UK by the Financial Services Authority, in Hong Kong by the Hong Kong Monetary Authority, in Singapore by the Monetary Authority of Singapore, in Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority ABN 30 101 464 528 (AFS Licence No. 241114) and in the US, by the New York State Banking Department and the Federal Reserve Board. The financial instruments described in this document are made in compliance with an applicable exemption from the registration requirements of the US Securities Act of 1933. In the United States, securities activities are undertaken by RBS Securities Inc., which is a FINRA/SIPC member and subsidiary of The Royal Bank of Scotland Group plc.
The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB.
The Royal Bank of Scotland N.V., incorporated in the Netherlands with limited liability. Registered with the Chamber of Commerce in The Netherlands, No. 33002587.
The Royal Bank of Scotland plc is in certain jurisdictions an authorised agent of The Royal Bank of Scotland N.V. and The Royal Bank of Scotland N.V. is in certain jurisdictions an authorised agent of The Royal Bank of Scotland plc.