Currency war. It’s when countries collect all their spare change, ready the sling shots and … Just kidding. A currency war—or less colorfully, a “competitive devaluation”—is supposedly where countries deliberately reduce exchange rates to gain an edge in trade. Many say we’re in one now and it will cause market mayhem—perhaps even ending in a 1930s-style scenario of devaluations and beggar-thy-neighbor trade tariffs. Eek! But a careful look suggests this narrative is pure fiction. We see no evidence of currency wars—just people reading way too much into normal monetary policy moves. In our view, currency wars are just one more false fear in the bull market’s wall of worry.
Here is what a competitive devaluation looks like in theory. A country deliberately weakens its currency to make exports more attractive to trading partners and thus boost growth. Competing nations say “hey, no fair, you’re stealing our exports!” and weaken their own currencies to regain the advantage. Then Country A says “oh no you don’t,” intervenes again, and back and forth they all go in a “race to the bottom.” As you might guess, it’s a race to nowhere. Exchange rates move in pairs, and a currency is only “weak” or “strong” relative to another currency. All you’d really get in a competitive devaluation is currencies leapfrogging each other.[i] No one wins. They’d all just bob around. Which makes us wonder, what’s the point?
The economic implications also make currency wars a bizarre choice. A weak currency isn’t an automatic boon in today’s globalized economy. While it makes exports cheaper abroad, it makes imports more expensive, hurting everyone who buys imported goods, like consumers. And businesses—including exporters. Few exported goods are 100% domestically sourced, so pricier components and raw materials cancel out many of the gains producers would otherwise get. There often isn’t a net benefit. In Japan, for example, the weak yen boosted export values, but the gains were solely from currency conversions. The quantity of exports struggled, production wasn’t goosed, and households and businesses were crushed by higher imported energy costs. That’s a big reason why Japan is in its third recession since 2009. That’s also probably why South Korea and Taiwan, two of Japan’s biggest trade competitors, didn’t devalue after the yen started weakening in early 2013. Many said they would—and yes, called it a currency war—but neither nation bit. They jawboned some but both chose not to fire back—and trade didn’t suffer. In 2013, when Japan weakened the yen through its quantitative easing (QE) program, South Korea and Taiwan’s exports grew (6.9% y/y and 1.2% y/y, respectively).[ii] Incidentally, some BoJ officials are questioning whether the weak yen is really so good.
Now, Japan’s QE was widely called a shot in a currency war—never mind that no one shot back—but that’s mostly a matter of opinion. Japanese policymakers did eye a weaker yen for its theoretical benefits, but aggressive QE was largely aimed at the domestic economy, which had endured about 15 years of deflation when the BoJ acted in early 2013. The weak yen was a byproduct of QE, not the overtly stated goal, and the G20 gave it a pass—despite rampant pressure, they didn’t accuse Japan of currency manipulation. They did the same this week, saying today’s supposed currency wars are just normal monetary policy. Now, we always take every proclamation from a cabal of politicians with a grain of salt, but their verdict seems pretty rational to us.[iii] While some exchange rates have fallen, this largely seems a side effect of monetary easing. Denmark’s Nationalbanken cut rates four times to defend its peg to the euro, which its law requires. The Reserve Bank of Australia cut its overnight rate to stoke growth in its struggling commodity-dependent economy. Ditto for Canada’s central bank. The Central Bank of Russia cut its key interest rate
due to pressure from Putin to combat an almost-certain recession. Singapore weakened its dollar because the exchange rate is its main monetary policy lever. These are central bankers acting in ways they believe appropriate to meet specific domestic goals—not a larger effort to compete in a global competitive currency devaluation.
So we don’t see a currency war. We also struggle to see how any of this would lead to some 1930s-style protectionist nightmare. That firestorm occurred as countries dealt with the US’s Smoot-Hawley tariff and the death of the 1920s version of the gold standard—devaluations then were much bigger and didn’t occur in a vacuum. Protectionism was much higher then. Today looks nothing like then. Today, we just have some countries loosening so they can hopefully grow faster. That would theoretically make them a bigger export market for alleged currency war losers America and Britain. Why throw up trade barriers and invite retaliation when you can capitalize on their growth instead?
Of course, we doubt anything we write here will end the currency war media buzz, because it is very buzzy. And hey, maybe that’s ok! This chatter has swirled since former Brazilian Finance Minister Guido Mantega made “currency war” a buzzword in 2010. Supposedly it was US vs. China in 2011. Japan vs. everyone in 2013. Yet since Mantega’s warning, global markets have returned 59.8%.[iv] So currency wars are … bullish?[v]
We kid, but only just. We simply see little evidence currency wars are an actual thing, let alone a big bad thing today that will kill this bull market. Rather, they seem like a big brick in that wall of worry bulls love to climb.
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[i] Or whatever the downward equivalent of leap-frogging is. Weak-frogging? Fall-frogging? Leap-toading?
[ii] Source: FactSet. South Korea and Taiwan total exports, y/y percent change from 12/31/2012 – 12/31/2013.
[iii] Their reasoning, which implies they don’t think the global economy can survive without aggressive stimulus of some sort, is another story. Suffice it to say, we think they underestimate the world’s strength.
[iv] FactSet, as of 2/12/2015. MSCI World Index returns with net dividends, from 9/30/2010 – 2/11/2015.
[v] Thank you sir, may we have another?