Not many countries nowadays seek a strong exchange rate; a few, including systemically important ones, are already actively weakening their currencies. Yet, because an exchange rate is a relative price, all currencies cannot weaken simultaneously. How the world resolves this basic inconsistency over the next few years will have a major impact on prospects for growth, employment, income distribution, and the functioning of the global economy.
Japan is the latest country to say enough is enough. Having seen its currency appreciate dramatically in recent years, Prime Minister Shinzo Abe’s new government is taking steps to alter the country’s exchange-rate dynamic—and is succeeding. In just over two months, the yen has weakened by more than 10% against the dollar and close to 20% against the euro.
European leaders have already expressed reservations about Japan’s moves. The US auto industry is up in arms. And, a few days ago, Jens Weidmann, the president of the Bundesbank, publicly warned that the world risks a harmful and ultimately futile round of competitive exchange-rate depreciations—or, more bluntly, a “currency war” (a term used previously by Brazil to express similar concerns).
Of course, Japan is not the first country to go down this path. Several advanced and emerging economies preceded it, and I suspect that quite a few will follow it.
It is just over a year since Switzerland surprised many when it announced, and strictly implemented, a threshold beyond which its currency would not be allowed to appreciate against the euro. And, remember, the country’s operating model for centuries has been to provide a safe haven for foreign capital.
One need not be an economist to figure out that, while all currencies can (and do) depreciate against something else (like gold, land, and other real assets), by definition they cannot all weaken against each other. In order for some currencies to depreciate, others must appreciate. Here is where things get interesting, complex, and potentially dangerous.
In today’s world, no significant group of countries is looking for currency strength. Some resist appreciation actively and openly; others do so in a less visible manner. Only the eurozone seems to accept being on the receiving end of other countries’ actions.
None of this is unprecedented, and there is a lot of scholarship demonstrating why such beggar-thy-neighbour approaches result in bad collective outcomes. Indeed, multilateral agreements are in place to minimise this risk, including at the International Monetary Fund and the World Trade Organisation.
Yet, when push