Since the financial crisis almost ten years ago, there have been several examples of significant currency depreciations among large developed economies. Such large currency moves invariably took place against a background of weak global growth. Inevitably accusations of currency manipulation began to be heard.
Currency manipulation is the deliberate attempt by authorities in a country to reduce the value of its currency in order to boost exports and stimulate economic growth. It is often referred to as a “beggar thy neighbour” policy as growth is bought at the expense of other countries’ exports in a zero-sum game. Currency wars then break out as countries attempt to regain export market share through currency manipulation of their own.
Currency wars a misnomer
However, the assertion that large currency falls over the last few years have been a zero sum game needs to be questioned. These currency moves did not take place in isolation. They were in large part a consequence of aggressive monetary ease that lowered interest rates and boosted money growth primarily through central bank asset purchases.
The effect of this is to boost domestic demand, some of which inevitably spills over into demand for other countries’ exports, offsetting the negative effect of the devaluation. This is true to varying degrees in those economies where quantitative easing (QE) was pursued following the financial crisis of 2008-09.
The US dollar devaluation, following the launch of its QE programme is the prime example – not surprising given the US is the largest economy is the world and the US dollar a global currency. The IMF estimates that, while the initial effect of a weaker US dollar was indeed to damage the exports of its trading partners, the overall effect on them was positive. There are several channels through which this took place: the main one being capital flows out of the US pushing up bond prices, reducing global interest rates. There has also been a wealth effect caused by rising global equity and other asset prices. This is in addition to the boost to US domestic demand stimulating its demand for imports.
To a lesser degree a similar second-round effect took place after QE was launched in the eEurozone (2014) and in Japan (2013). There is less evidence of this in the UK following the launch of QE in 2009. But the UK economy is much smaller than the other three so it is not surprising that no such effect has been identified.
The time lags between policy moves also suggest that there were no currency wars. Japan (2013) and the eurozone (2014) launched their QE programmes several years after the US (2009) and UK (2009), for example.
China has been a currency manipulator – but is no longer
However, there is one large economy where the currency manipulation argument has potential validity and that is China. The Chinese authorities almost certainly did manipulate the yuan during the period early last decade following China’s admission to the WTO. During this period rapid economic growth was explicitly driven by exports, facilitated by a cheap currency.
But more recent accusations of currency manipulation by China are wide of the mark. In recent years Chinese policy has shifted towards supporting greater consumption and domestic demand with less reliance on exports. This underscores the reduced role for the exchange rate in Chinese policy making. Chinese exports have become less competitive in recent years as costs – especially for labour – have risen sharply. Neither the IMF nor even the US Treasury judge China to be a currency manipulator at present. Indeed recent attempts by the Chinese authorities have been geared towards stabilizing the currency in an attempt to limit capital outflows and support a fragile banking system. It is telling that, despite his rhetoric during the election campaign, President Trump has not declared China to be a currency manipulator.
Nor can Germany, President Trump’s latest target be labelled a currency manipulator – monetary policy is conducted by an independent European Central Bank, which is still pursuing an asset purchase programme at the same time as the US is raising interest rates. Germany’s large current account surplus is a result of chronically weak domestic demand that produces savings in excess of investment – it is not a function of a cheap currency.
Suspicions exist about some Asian economies
But that is not to say that currency manipulation is now only a matter of historical interest. South Korea and Taiwan are prime suspects in this respect. But neither has been designated a currency manipulator.
Protectionism is on the increase
Currency wars and manipulation may have diminished if not completely disappeared as an issue, but a more general threat to global trade arises from increased protectionism. This trend pre-dates President Trump and the withdrawal of the US from the Trans-Pacific Partnership (TPP). The WTO has identified a significant rise in trade restrictions in recent years. (Examples of trade restrictions include import or export tariffs or their increase, import bans or quantitative restrictions, local content requirements) In the six months to May last year the WTO recorded an average of 22 new trade restrictions per month, the highest since 2011.
The case for free trade needs to be made – again
There is a clear risk that the new US administration will preside over a significant rise in protectionism given the “exports good, imports bad” mentality so far adopted by President Trump. This concern about a protectionist trend was undoubtedly behind the publication earlier this month of a joint report by the WTO. IMF and World Bank called “Making Trade an Engine of Growth for All”. As the title suggests this report makes the case for the benefits of free trade while acknowledging the need for policies to help those who suffer economic loss as a consequence.
At their worst currency wars can be a zero-sum game, but trade wars are invariably a negative-sum game. Trade wars rather than currency wars are the more significant threat to global prosperity.