Currency War?

Quantitative easing (QE), also referred to as monetary easing, is an unconventional monetary tactic used by a country’s central bank to boost money supply in hopes of stimulating economic activity; essentially, it is the process of ‘printing money.’ For instance, in the United States, quantitative easing is done by way of selling treasury bonds to increase the amount of excess reserves held by the Fed. QE is used to devalue a currency and control the exchange rate—which in turn affects the international price of a country’s goods. The manipulation of the exchange rate can be an attractive solution in times of recession. The problem with quantitative easing is the uncertainty that comes with it—the right balance has not been found.

Image courtesy of Mr. Wabu, © 2004, some rights reserved.
Image courtesy of Mr. Wabu, © 2004, some rights reserved.

When the Fed in the United States chooses to implement quantitative easing, the ramifications can be significant worldwide. The policy is imitated because countries do not want their currency to appreciate against the dollar. There is potential for significant negative externalities to quantitative easing, which may be exemplified in QE2 and QE3. In other words, what may be good for the United States during a recession may not be good for an emerging economy. For instance, QE2 in the United States impacted a “liquidity flood” in food markets. China worried that with the introduction of QE3, social unrest would be generated in Mainland China because of soaring food prices.[1] It is for these reasons that in 2010, Guido Mantega, the finance minister of Brazil, remarked, “we’re in the midst of an international currency war. This threatens us because it takes away our competitiveness.”

A currency war occurs when a state attempts to manipulate and devalue their currency to remain competitive This February, the Group of 20 (G20) met in Moscow to discuss the issue of “currency war” after the latest news of the devaluation of the Japanese yen. The yen has dropped 20 percent as a result of Japan’s aggressive monetary policy used to try to stimulate the economy. Japan first experimented with quantitative easing over a decade ago in 2001. For five years, Japan bought significant bonds, but stopped the program in 2006 upon seeing improvement. Some believed the program had worked, until deflation returned with a vengeance in 2008 due to the financial crisis. Just as the market was beginning to recuperate, Japan faced another devastating loss—the 2011 tsunami. Overnight, Japan’s economy went from being the second largest in the world to the third. Ultimately, the G20 concluded that we are not in the midst of a currency war, which essentially means they are not prepared to condemn artificial currency manipulation in times of economic hardship. The G20 finally agreed to a “commitment to refrain from competitive devaluations and stated monetary policy would be directed only at price stability and growth.”[2]

So is Japan initiating a currency war? All evidence points to no—Japan’s economy has never properly recovered from the burst of the asset bubble in the early 1990s. In fact, newly elected Prime Minister Shinzo Abe is being celebrated for his aggressive monetary policy. Since the G20 determined that currency manipulation should always be based on market conditions, it seems that Japan’s actions will not be judged harshly. Based on a mercantilist perspective of economic policy, quantitative easing is good—but does it work? Unfortunately, there is no clear answer to whether or not quantitative easing works. In the case of Japan, it seems that quantitative easing may be the best possible route to recovery after a series of unlucky events, i.e. the financial crisis and the tsunami. Though the G20 did not specifically comment on Japan, it appears that they are condoning the economic policies of the new prime minister.

The decision of the G20 has significance because if they are not criticizing the actions of Japan, they will not criticize the actions of the most significant manipulators of currency like Singapore or even the United States. But never fear! As for now, currency warfare is not afoot. And maybe if we’re lucky, the Brazilian finance minister will eventually agree with us.

[1] Emmaunel Martin, “QE3’s Nasty Surprises.” IEA. Institute of Economic Affairs, 19 Oct. 2012.

[2] “G20 Steps Back from Currency Brink, Heat off Japan.” Reuters, 16 Feb. 2013.

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