RaboResearch - Economic Research

Thou shalt not beggar-thy-neighbour

Economic Comment


The world’s largest developed nations committed not to target exchange rates in a G7 statement published on Tuesday. The statement is aimed at addressing concerns over a fresh round of global currency wars. This comes ahead of the meeting of the Group of 20 finance ministers and central bankers in Moscow on Friday. Undoubtedly, currency movements will be high on their agenda as well.

One of the primary reasons for the renewed concerns about exchange rate movements is the election of Shinzo Abe as Japan’s new Prime Minister. Since assuming office, Mr. Abe has declared war on Japan’s long-term deflation and has vowed to do everything in his power to increase consumer prices. To achieve this goal, Mr. Abe has forced the Bank of Japan to increase its inflation target to 2%. This should be met by increasing asset purchases next year and maintaining an ultra-loose policy stance. Market participants have taken the new policy regime, informally known as ‘Abenomics’, as a sign that the Japanese authorities favour a weaker yen in order to reach their goal. Against this backdrop, the yen experienced a major sell-off over the past few weeks. Between end of October 2012 and February 11, 2013, the Japanese currency depreciated by a whopping 14.5%-points on a trade-weighted basis (figure 1).

Some policymakers are worried that this may be the beginning of a global currency war. To be sure, monthly data of trade-weighted exchange rates available till end-2012 suggest that there are some other G20 countries that have also witnessed a marked improvement of their competitiveness at the expense of their trading partners (figure 2). In any case, history has shown that beggar-thy-neighbour policies through currency manipulation will not be beneficial as it increases the risk of tit-for-tat retaliation. This can be through currency depreciation, whereby no one gains, or worse through protectionist measures such as raising tariffs, red-tape, etc. Thus, we have to see whether world leaders will come together to once again denounce protectionist measures in every form. The last thing the global economy needs at this moment is for protectionism to throw sand in the wheels of the recovery. The fact that the G7 countries said that they would “consult closely” on any action in foreign exchange markets gives us reason for hope

Figure 1: Currencies of the adv. G20 countries
Figure 1: Currencies of the adv. G20 countriesSource: Bank of England
Figure 2: Currencies of all G20 countries
Figure 2: Currencies of all G20 countriesSource: BIS

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