Quantitative easing does not equal competitive currency devaluations – at least that's the message the Group of 20 tried to convey at its April 18-19 gathering. But in the real world, QE does depress the value of a currency and causes international tension and market distortions.
Instead, QE is all about stimulating economic growth and a weaker currency is just an unfortunate side-effect. And on that note the Japanese had a particularly good summit as their aggressive re-inflation policies were effectively endorsed. Meanwhile, JPY is likely to weaken further, much to the discomfort of Japan's trading rivals.
The big trade-off that Japan and the international community are betting on is that the country's monetary policy will revive economic growth, which will be to everyone's benefit. It would be ironic, however, if that growth came about due to more exports rather than through increasing expenditure by domestic consumers. Rather than spending, many Japanese households may instead decide to invest their money abroad to safeguard its value.
Japan started tinkering with QE as far back as 2001, but used it on a more modest scale than the U.K. and U.S. and was mainly deploying it to help its shattered banking system cope with rapidly deflating asset bubbles and financial stress.
In terms of scale Japan is catching up with the U.S. and U.K. in quick time with a view to using QE to stimulate sustainable economic growth. There is, however, no guarantee that this will happen and it may prove to be a dangerous monetary experiment. Nonetheless, it is also an attempt by Japan's new government to grapple with its deeply unsustainable fiscal position with a GDP to debt ratio of around 230% and climbing.
Economic growth – whatever it takes
Reviving sustainable economic growth and creating jobs moved up the agenda at this G-20 meeting. Tolerating Japan's stimulus efforts even with a weaker currency also allows plenty of scope for other countries to do the same if they deem it necessary. The G-20 will simply be “mindful of unintended negative side effects stemming from extended periods of monetary easing.”
With the IMF foreseeing slower global growth, the scene could be set for more rounds of QE from other countries, in particular the U.K. and maybe even the U.S. if sequestration starts to sap private sector consumption. It's possible that even the European Central Bank could eventually move toward QE type policies, particularly if the German economy is hit by recession.
Another notable from the G-20 event was to put off the day that governments running large fiscal deficits try to put their books in order. 'Austerity' is becoming a dirty word given Europe's experience with it, which in many ways mirrors attempts by governments during the 1930s to balance their books, which helped prolong the Great Depression.
Day approaching for free floating CNY?
Another important event is China's talk of widening the trading bands for its currency and liberalizing the CNY may be sped up. A free floating Chinese currency – if and when it happens – would be a very significant addition to forex markets given China is the world's second largest economy. CNY would no doubt quickly become a major reserve currency and would support China becoming a major financial center. USD/CNY would eventually become one of the most heavily traded currency pairs. But liberalization is likely to be many years away as China, like most other countries, doesn't particularly want a strong currency at this point, which would risk chocking off exports.
However, it was clear that there is plenty of tension simmering not that far beneath the surface at the G-20. South Korea is still very unhappy over Japan's re-inflation policies and there is deep division between the U.S. and Germany regarding fiscal policy. Many emerging market countries with more robust economies remain concerned over the distorting effects of aggressive QE activity from developed nations.