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Currency wars get a diplomatic make-over from G20

Currency wars get a diplomatic make-over from G20 Anthony Harrington

The phrase "currency war" is undoubtedly an emotive one and the G20 at its February 17th/18th meeting, along with IMF chief Christine Lagrange and the European Central Bank president Mario Draghi, has been doing its best to wrestle this particular bone away from the media and to portray the wild swings in the FX markets seen over the last months as merely the result of domestic governments pursuing domestic issues, no war at all, in fact.

However, the smaller grouping of the world's seven richest nations, the G7, which met in advance of the G20, did feel it necessary to fire a warning shot across the bows of the world's third largest economy, Japan, after some excitable comments from senior Japanese government figures, who were talking about aggressively depreciating the yen to stimulate the country's stagnant economy. After the G7 meeting on 12 February, the group issued the following statement:

"We, the G7 Ministers and Governors, reaffirm our longstanding commitment to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets. 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. We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability. We will continue to consult closely on exchange markets and cooperate as appropriate.”

Nothing new here, as the statement itself makes plain ("we reaffirm our longstanding commitment to market determined exchange rates"), so why say it? Well, because Japan's new Prime Minister Shinzo Abe has been calling for a more aggressive monetary stimulus from Japan's central bank. To Morgan Stanley and others, this is all about aggressively devaluing the yen to create a trade advantage by making Japanese exports cheap. Morgan Stanley actually used the term "competitive depreciation" when analysing the Bank of Japan's actions in a briefing note to clients.

However, in these matters rhetoric and what you call actions has an importance that is way beyond its "truth" content. By saying there is no currency war going on, the G20 in effect made it so. Japan would now have to step over the line and do something really blatant to reignite tensions. Commenting in Moscow, where the G20 meeting was taking place, IMF chief Christine Lagarde had no hesitation in dismissing concerns over currency wars.

"There has been lots of talk of currency wars and we have not seen any such thing as a currency war. We've heard currency worries, not currency wars. We've not seen confrontation but deliberation, dialogue, discussions and clearly this G20 meeting has been extremely helpful and productive," she said.

The fact of the matter is that Japan's monetary policies, including aggressive quantitative easing measures, have seen the yen drop 20% in recent months.

However, currencies can rise and fall for a variety of reasons. The euro soared to a high of 1.37100 on 1 February against the dollar and, following the stalemate over the Italian elections on the morning of 26 February it plunged to 1.30220, some 6,900 points (690 pips). When the euro was en route to 1.37 many expected the ECB president Mario Draghi to intervene to weaken the euro on behalf of Europe's greatest exporting nation, Germany, but the message from the ECB was that the euro was not significantly overvalued - meaning that the ECB had every intention of not engaging in currency wars. However, Draghi also managed to hint of a potentially more "dovish" stance for the ECB, such as cutting interest rates still closer to zero, if it was deemed appropriate. That in itself started the euro on the slide and the Italian elections seem to have completed the process for now - meaning that whether it wanted to or not, the euro has now effectively seen a significant "competitive devaluation", particularly when viewed against the backdrop of its recent highs.

It will be interesting to see how the Federal Reserve reacts to this relative strengthening of the dollar against two of its major trading currencies, the yen and the euro. Certainly dollar strength will not help US exporters press into new markets. The political elite may jaw about all being sweetness and light on the currency front, but at the coalface things could get down and dirty very quickly.

Further reading on FX

Tags: Bank of Japan , Christine Lagarde , Federal Reserve , fiscal stimulus , G20 , G7 , IMF , Japan , Japanese Prime Minister , Lagarde , Shinzo Abe , stimulus
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