The Japanese are doing it again. The Koreans prefer to do it when nobody’s watching. The Chinese are at it brazenly and, like everything else they do, on an enormous scale. The Swiss tried it, without much success.
The “it” is government interference in the foreign-exchange market. The aim? To make their currency cheaper, thus making life easier for their export industries and harder for foreign companies selling to their consumers. The big question is what this says about the shifting landscape of the post-crisis world.
Historically, Western governments were too high-minded to manipulate currencies directly. That was considered to be the province of Third World despots with a limited understanding of economic theory. Even so, currency policy in the West has been far from the benign neglect of free-market ideology.
In the 1990s, then–U.S. Treasury secretary Robert Rubin repeatedly assured the world that a strong dollar was in the U.S.’s interests. Earlier the U.K. Treasury made the disastrous decision to “shadow the Deutsche mark,” linking the pound to the world’s strongest currency. In both countries policymakers saw currency strength as a symbol of economic virility.
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In the context of the times, that made perfect sense. Both countries spent most of the past 30 years living beyond their means. Inflation was relatively high; the natural tendency of the dollar and the pound was to fall. Bolstering confidence in the currency kept the show on the road. It put a lid on inflation and encouraged creditor nations to carry on lending—which allowed consumers to carry on spending and politicians to carry on getting elected.
Meanwhile, Asian countries favored their exporters—through subsidies, tariffs, and, not least, undervalued currencies. In the 1980s and ’90s the resulting imbalances were contained for two reasons. First, they were still small in relation to U.S. economic scale and power. Second, the U.S. was the ally and protector of the rising Asian powers. When Japan’s surpluses became a political problem in the mid-1980s, the two countries engineered a massive appreciation of the yen and Japanese auto companies began to build job-creating factories on American soil. Conditions today could not be more different. In the developed countries, inflation is dead as a political issue. Scrimping and saving is the new borrowing. Reducing unemployment of workers is crucial to saving the jobs of politicians. So governments everywhere want weak currencies—to boost jobs at exporters and prevent the hollowing out of domestic industry.
History agrees. The last time deflation spread around the world, in the 1930s, the countries that came off the gold standard the soonest—equivalent to devaluing your currency, in today’s terms—recovered the quickest. Those that stuck the longest to the high ground of economic orthodoxy, France and the United States, plunged into depression. That’s why even the sober Swiss are trying to depreciate their currency. True to form, the U.K. and the U.S. prefer methods that are less blatant. Bank of England governor Mervyn King crafted a quantitative-easing (QE) program that created new money equivalent to 15 percent of U.K. GDP. The subsequent decline in the pound he termed “helpful.” President Obama’s target of doubling U.S. exports in a feeble global economy could hardly be accomplished with a strong dollar.
The problem is that currency depreciation is a zero-sum game. China says that a big revaluation of the yuan would do serious damage to its economy, which is probably true. China’s critics say the undervalued yuan destabilizes the rest of the world. That’s true, too.
Currency spats reflect the fracturing of the system that drove global growth for three decades. Today’s China will not act like the Japan of the 1980s. Today’s U.S. will not act like the U.S. of the 1980s. Without a solid world economic recovery, it will be impossible to contain the escalating economic frictions.
Economic fracture brings political fracture. The expulsion of Roma immigrants in France, the controversy about undocumented workers in the U.S., the rise of new populist forces in the U.S. and Sweden—this could be a taste of what is to come. As in the 1930s, when the struggle for competitive advantage intensifies, the rule book goes out the window.
All the more reason then to prioritize growth and pull every lever that might encourage it. That includes tax cuts, public investment, and, yes, QE—which has another “helpful” effect of driving up the stock market. The alternative is too dismal to contemplate.