Economics: Central Bank and Global Currency Debate Essay

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There's a back to the future feel about the global economy right now. The only question is back to what future? The obvious answer considering the events of the past week is the 1970s. There are plenty of echoes in the world today of the currency instability, rising inflation, rising unemployment and political uncertainty that marked that troubled decade.

Over the weekend, finance ministers and central-bank governors from the Group of 20 industrialized nations tried to play down fears of new currency wars that have been spooking markets since last month's election of a new Japanese government. The Bank of England recently became the latest central bank to relax its inflation-fighting credentials by formally abandoning its long-standing objective of returning inflation to its 2% target within two years. Meanwhile European gross domestic product shrank by more than forecast in the fourth quarter, creating fresh uncertainty over when the recession will end.

But it doesn't take much of a leap of imagination to see shadows of a very different decade: as in the early Noughties, the dominant dynamic in the markets today is a desperate search for yield that is fueling potential asset bubbles across global markets. Just as the U.S. Federal Reserve loosened monetary policy in the aftermath of the dotcom crash, central banks have been again flooding the world with easy money to try to pull the global economy out of its current malaise. And as in the past decade, there is evidence that all this liquidity is leading to asset-price inflation even as consumer-price inflation remains low, with concerns about bubbles in assets as varied as Swiss, Canadian and London real estate, emerging-market equities and the European corporate-credit market.

At the same time, some believe Warren Buffett's proposed $28 billion takeover of Heinz may mark the start of a new giant leveraged buyout boom. On this analysis, the seeds of the next financial crisis may be being sown before the current one is over.

So which decade will the current one resemble? The reality is that talk of 1970s-style currency wars looks premature. True, the G-20 statement designed to cool anxieties was bland and unconvincing; it acknowledged that 'excess volatility of financial flows and disorderly movements in exchange rates have adverse implications for economic and financial stability' and it committed governments to 'refrain from competitive devaluation.'

That still leaves ample scope for further devaluations so long as they happen to be the serendipitous byproduct of domestic monetary policy pursued for domestic reasons rather than efforts to 'target our exchange rates for competitive purposes.'

Indeed, the global currency debate is full of humbug. The U.S. was the first country to be accused of waging currency war, when Brazil objected to the Federal Reserve's second round of quantitative easing in 2011, which was widely seen as a naked attempt to drive down the dollar.

The new Japanese government may now claim that its promise of a massive monetary and fiscal stimulus is solely designed to boost the domestic economy but it has made little secret of its desire to see a weaker yen. Similarly, Bank of England Governor Mervyn King has been open in his view that a further devaluation of sterling, on top of the 20% depreciation since the start of the global financial crisis is needed to further rebalance the economy─even while warning that other countries risk triggering competitive depreciations.

In fact, Mr. King could be said to have coined a new irregular verb: 'I rebalance my economy, you competitively devalue, he has started a currency war.'

Even so, there are good reasons to believe that talk of currency wars is, for the moment, just talk. First, it is hard to argue that any advanced economy has so far secured a significant competitive advantage via its exchange rate. Even after Japan's near-20% devaluation this year, the yen is still trading within
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