Currency wars are alive and well and despite G-20 agreements not to engage in competitive devaluations, there is in fact little appetite among the perpetrators to call it a day. If anything it could get worse with dangerous consequences for the world economy.
So, soon after the G-20 agreement Martin Weale, a policy maker at the Bank of England, was talking about how a weaker GBP would benefit exports. Markets read that as the Bank of England desiring the GBP to go down and it duly responded hitting a seven-month low against the U.S. dollar at one point. Even the relatively conservative European Central Bank has made some connection between growth and exchange rate levels. Should EUR/USD start moving sharply up again, that well anticipated ECB rate cut might well be forthcoming.
Indeed, the main take-away from the G-20 for the currency warriors is to make their objectives less obvious, but even that courtesy might be ignored as shown by Weale. The U.S., U.K., Japan and the Eurozone are desperate to grab a slice of someone's else's growth if they can't generate any of their own.
For countries on the receiving end of this policy, such as Brazil, South Korea and Australia to name a few, there is little they can do other than scale up the rhetoric. But eventually even they might be tempted to take more extreme actions if their economies are damaged by competitive devaluations.
GBP/JPY chart – A race to the bottom
Japan, which so blatantly talked its currency down over recent months, escaped public reprimand at the G-20 as it no doubt has some allies, such as probably the U.S. and U.K. Though there might be some respite on JPY for a bit as it is near the target of USD/JPY 100, which Japanese officials have talked about. The next catalyst for JPY could come in March with the appointment of the new Bank of Japan governor or even until it starts its open ended asset purchasing programme next year.
But the major challenge for Japan, and increasingly for western countries, is ageing populations. Japan is ahead of the West in this regard with nearly a quarter of its 128 million citizens over the age of 65 and by 2060 that is forecast to rise to 40% with the population shrinking to 87 million people. No doubt this is one reason why Japan leads the world in automation and robotics as it tries to replace its shrinking workforce – the country's preferred alternative to immigration.
Older people and especially retirees tend to spend less than their younger counterparts. Accounting for the fact that household consumption makes up 60% of Japan's GDP and it is clear that exports are the only real short- to medium-term driver left for boosting its economy. The problem with an exporting strategy is that nearly all developed countries face demographic decline including China, Russia and even South Korea and Taiwan. It is a situation unprecedented in human history.
It is highly unlikely that another spending spree on infrastructure projects and more money creation is going to compensate for, let alone reverse, the structural decline in household consumption in Japan and other countries. The risk is that if Japan were to succeed in stimulating inflation it may actually slow its economy even more if consumers see their spending power eroded.
History suggests that global currency wars end badly and with good reason as they are a zero sum game. The one in the 1930s led to trade protectionism and made the great depression worse and the second one during the 1960-1980s helped fuel bursts of high inflation in the 1970s.
The aftermath of a severe banking crisis and the growth-draining nature of demographic decline sets the perfect conditions for currency wars and beggar thy neighbour policies. Until those influences are more clearly acknowledged by policy makers the temptation for currency devaluations will persist.