Thursday, February 14, 2013

Root causes of currency wars

"...Accusations that governments have engaged in a currency war have met with several robust responses. As we will see, these responses are themselves pretty revealing. They are:
1. The 'just following orders' defence.
This defence was put well by Philipp Hildebrand, the former head of the Swiss National Bank, in an op-ed piece in this Tuesday’s Financial Times (Hildebrand 2013). In his view, central banks haven’t declared war on trading partners. Rather they’ve sought to revive their national economies taking steps – and this is important – that are entirely consistent with their legal mandates. Of course, critics will hardly be satisfied (a) as the cross-border adverse knock-on effects of monetary easing are what they are, (b) just because something is allowed doesn’t mean it is the right thing to do and (c) that this defence demonstrates just how parochial central bank mandates are.
2. The 'no malice' defence.
In their statement this week the G7 implicitly proffered this defence (G7 2013). Monetary policy that does not seek to target exchange rates is fine on this view. No harm was intended, so what’s the problem? Critics will point to the adverse effects of monetary easing on trading partners and won’t be satisfied with assurances on intent.
3. The omelette defence.
The omelette defence is the ultimate acknowledgement of the inevitability argument. If “you can’t make an omelette without breaking a few eggs”, and assuming you want an omelette, then accept the fate of the eggs. Seeing their commercial interests and economic recoveries treated as such eggs is exactly what worries policymakers in emerging markets.
4. The 'grabbing headlines' counter-attack.
It is said that sometimes that attack is the best form of defence. In this case this amounts to arguing that those who raise currency war concerns are trying to deflect criticism away from their own policy choices. Accusations of beggar-thy-neighbour acts by trading partners are merely a smoke screen for failed domestic policies on this view. This week’s news reports suggest that the governments worried about the currency war have spread beyond the 'usual suspects', so not every critic may be vulnerable to this counter-attack (FT 2013).
5. The Connally defence.
The omelette defence isn’t the only hardball option available to large countries engaging in monetary easing. The fact that prior criticism doesn’t appear to have altered central bank behaviour suggests that there may be another element in their calculations. Those engaging in monetary easing and in some cases direct currency intervention (such as the Swiss) may have concluded that their trading partners either wouldn’t dare or ultimately wouldn’t care enough to retaliate or that the policy options available to harmed trading partners are so unpalatable (such as putting in place capital taxes and controls or resorting to widespread protectionism) that those options would not be implemented. This is a version of the Connally defence named after the US treasury secretary who reacted to European criticism of US economic policy in 1971 by saying: “The dollar is our currency, but your problem.” On this view, the rest of the world needs to adjust to the reality of monetary easing and live with its consequences. One might ask what assumptions are being made about foreign acquiescence and whether foreign governments see the policy choices before them in the same way – and whether they are right.
The status quo, then – which has led to repeated outbreaks of the currency war – has plenty of defenders. Were there really no alternatives?..."

at http://www.voxeu.org/article/root-causes-currency-wars

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