The present currency war started with the Great Monetary Experiment under the Obama administration. This triggered a devaluation of the dollar through 2010–12. Since then the launch of similar and in some ways more radical monetary experiments in Europe and Japan have fuelled big devaluations of the euro and the yen. Meanwhile a combination of bubble credit policies and intensified repression has caused the Chinese currency to slide.
So far the Trump administration has not formulated a clear message concerning the currency war. Instead there has been a series of sound bites about particular aspects of the war which miss the key source of this conflict — the flawed global 2% inflation standard. In turn the German chancellor and Japanese prime minister have made indignant responses to Trump’s sound bites, pretending that the ECB (European Central Bank) and BoJ (Bank of Japan) respectively are institutions independent of the government, and so the German and Japanese governments are not responsible for currency consequences of monetary policies.
The Donald Trump Factor
Let’s start with the comment by President Trump’s top trade advisor Peter Navarro that “Germany is using a grossly undervalued euro to exploit the US and its EU partners.” The underlying reality is that Chancellor Merkel in the defence of the European status quo (including European Monetary Union [EMU] in its present form) has backed ECB chief Draghi pursuing policies of radical monetary ease. She could have said no. She did not.
Indeed the evidence points to a war conspiracy. Finance Minister Schaeuble admitted in a recent newspaper interview (inTagesspiegel) that Berlin agreed (back in 2014) not to express in public its disquiet about radical monetary policies of the ECB on the understanding that the ECB would take responsibility for the widening German trade surplus. In effect Berlin would plead innocence on the basis of ECB independence and Chief Draghi would back that plea. The conspirators did not reckon with the rise of Donald Trump.
German and Japanese Monetary Scheming
No doubt the government in Berlin did reckon correctly that radical ECB policies would become growingly unpopular with big sections of the German public. Points of resentment would include the substantially negative real rates on savings and the transfer of huge volumes of capital via the ECB into weak sovereigns and banks (most of all in Italy). There are also, however, many citizens who have gained from the export boom (fuelled by the weak euro) and the property construction boom.
In effect, the cheap euro has provided an essential political lifeline to Europe’s present-day Chancellor Metternich (Merkel). Undeclared currency warfare by the unloving Merkel-Draghi couple has been the means of restraining the forces of domestic political resentment in Germany against the growing costs of EMU.
Yet if the only way for Berlin to sustain the European status quo is to permit ECB chief Draghi to effectively manipulate the euro downward, then we should conclude that monetary union in Europe as presently designed and implemented is inconsistent with global free trade and a liberal global order. The challenge for the European elites or their successors who might want to retain the union would then be to open up another channel of survival — most plausibly featuring de-regulation, smaller government, and sound money.
Turn next to PM Abe’s retort against President Trump’s comment (January 30) that “Japan and China use monetary policy to pursue devaluation and that they play the money market whilst we sit here like a bunch of dummies.” It has been an open secret from the start that a key purpose of PM Abe putting Japan on the global 2% inflation standard (from January 2013) was to get the yen down from its lofty highs reached under the US currency offensive of 2009–12. And now the extraordinary BoJ policy of potentially unlimited money printing to hold the long-term interest rate at just above zero when US long-term rates have been rising sharply is a continuation of that same currency policy. Beyond winning the verbal tit-for-tat with Europe and Japan, Washington has yet to put the world on notice that the days of the 2% global inflation standard are over. Yes, this standard has lasted twice as long as the effective life of the Bretton Woods System (from 1959 to the two-tier gold market’s introduction in 1968) but it is manifestly rotten — as powerfully illustrated by the currency war which it has spawned and also by the succession of asset price inflations and busts.
What Trump Should Do
The Trump administration could show leadership here by signalling that it intends to nominate successors to Yellen and Fischer who would take the US off the 2% inflation standard and that it would back legislation in Congress that would prevent the Fed from interpreting the mandate of price stability as perpetual inflation at 2% per annum.
Senior US international economic officials would make absolutely clear that the pursuance of currency devaluations under the camouflage of breathing inflation back into the economy (whether Europe or Asia) to reach a 2% inflation target is no longer acceptable. The premise should be that non-standard monetary tools (QE, negative rates, long-term rate pegging) are evidence of currency manipulation intent.
The Trump administration would foreswear the use of these tools by the US (introducing legislation for that purpose). Most importantly it would publish a charge sheet of monetary and other policies which should be under suspicion as a form of currency manipulation.
Chinese Financial Repression
The sheet would include first, sustained intervention in foreign exchange markets and exchange restrictions; second, monetary experimentation in pursuit of inflation targets; and third, “financial system manipulation and repression.” The third point would have obvious relevance to US-China negotiations.
Beijing enforces a regime of financial repression which essentially steers bank credit to favoured state enterprises whilst reducing rates of return on secure savings; its credit policies induce one bubble after another (and many together); political repression adds to the fears regarding safety of domestic assets. And so Chinese citizens seek safety and income on their non-gambling funds (domestic real estate and credit products are huge wagers) outside China. The resulting massive capital flight presses the Chinese currency downward.
Armed with its charter of prescription against manipulation, the Trump administration could take the high road in its coming trade confrontations with Beijing, and also more widely with Europe and Japan. Infringement of the charter would be grounds for the start of “action” by the US under existing trade legislation.
In Tokyo, PM Abe is likely to get the message, given the importance of good relations with Washington at a time of rising geo-political tension, especially regarding China and North Korea. But what if Frau Merkel and her central banker fail to get the message? German citizens fortunately have the chance to vote for currency peace and against trade war this autumn. For the Chinese there is no such potential exit from war danger via the ballot box.
Brendan Brown is the head of economic research at Mitsubishi UFJ Securities International.
