Home » Currency War » Welcome to the Currency War, Part 6: Japan Gets Explicit

Welcome to the Currency War, Part 6: Japan Gets Explicit

by John Rubino on December 26, 2012 · 13 comments

Forget about the fiscal cliff. December’s big story was the ascension of a new leader in Japan whose platform is aggressive inflation:

Global Currency Tensions Rise
TOKYO — Japan’s incoming prime minister fired a volley into increasingly tense global currency markets, saying the country must defend itself against attempts by other governments to devalue their currencies by ensuring the yen weakens as well.

Shinzo Abe’s call comes as others including Bank of England Gov. Mervyn King warn that the world’s economic-policy makers risk becoming embroiled in currency spats that could heighten tensions among countries.

Mr. Abe on Sunday called on Japan’s central bank to resist what he described as moves by the U.S. and Europe to cheapen their currencies and noted that a yen level of around 90 yen to the dollar — it was at 84.38 in early Asian trading Monday, down from 84.26 yen late Friday — would support the profit of Japanese exporters.

“Central banks around the world are printing money, supporting their economies and increasing exports. America is the prime example,” said Mr. Abe, referring to the Federal Reserve’s policy of flooding the market with dollars by purchasing massive amounts of Treasury bonds and other assets.

“If it goes on like this, the yen will inevitably strengthen. It’s vital to resist this,” he said.

Mr. King, in an interview this month, said, “I do think 2013 could be a challenging year in which we will, in fact, see a number of countries trying to push down their exchange rates. That does lead to concerns.”

It was part of an effort by countries to preserve trade advantage, he said. “The policies pursued by countries for domestic purposes are leading to tension collectively.”

What is notable about Messrs. Abe’s and King’s comments is that the scope of global currency angst seems to be expanding. China, which manages its exchange rate to keep it closely aligned with the U.S. dollar, has long been the object of global criticism for its efforts to hold down the value of its currency in an attempt to boost exports.

Since the financial crisis, other countries — including Switzerland, Israel and South Korea — have ramped up their efforts to prevent their own currencies from getting too strong amid worries about their export competitiveness. Policy makers in Australia also are under increasing pressure to fight the rise of the Australian dollar.

Global central bank foreign-exchange reserves expanded to $10.5 trillion by mid-2012 from $6.7 trillion in 2007, according to the International Monetary Fund, a 57% rise in less than five years and a sign of how aggressively world central banks are stockpiling other currencies in an attempt to prevent their own currencies from getting too strong in the wake of the 2008 financial crisis.

The largest increase has been in Switzerland.

It is “completely different” for Japanese companies if the dollar is in the 80-yen range, as it is now, as opposed to the 90s yen, Mr. Abe said. If the dollar “is above 85 yen, companies that haven’t been paying taxes until now [because they don't have profit]. . .can pay taxes.”

The U.S. hasn’t explicitly sought a weaker dollar. But the effect of its policies has been to suppress its value. Most notably, the Federal Reserve’s quantitative-easing programs — in which the central bank prints dollars to purchase government bonds — have the side effect of holding down the international value of the currency by increasing its supply in global markets.

Trade wars, in which countries restrict imports from other countries, were an important feature of Depression-era policies in the 1930s which crimped global economic growth. Mr. Truman said he had grown concerned that cooperation between countries on currency decisions had diminished in recent years.

If it continues, he said, then “you go from a world in which there is a broad level of cooperation on monetary measures to one in which it is every man for himself,” he said.

Some thoughts
The crucial sentence in the above article is: If the dollar “is above 85 yen, companies that haven’t been paying taxes until now [because they don't have profit]. . .can pay taxes.”

There, in a nutshell, is why currency wars happen. Heavily-indebted governments are desperate for tax revenue, and an export sector that can’t compete because of a strong currency produces very little taxable profit.

But before you write in to say that a strong currency is no barrier to profitable exports for well-run countries, note that “well-run” doesn’t apply to today’s developed world. Currency wars generally happen when corrupt, over-indebted countries can’t cover their interest expense and start looking for a way to shift the burden of their stupidity onto their trading partners. A weaker currency is only a short-term fix, but when an election approaches (and one is always approaching), short-term fixes are good enough.

For a sense of the panic that’s gripping Japan, consider what’s happening to its big electronics exporters like Sony and Sharp:

A strong yen isn’t the only reason for this implosion, of course. Apple and Google and falling TV prices are the real existential threats. But the Japanese central bank can’t kill Apple and Google, while it can weaken the yen.

2013 is shaping up as a pivotal year, not necessarily because inflation is set to accelerate, but because virtually everyone who matters has decided to try, explicitly, to make it accelerate. This might take a while, because the ongoing contraction in Europe and failed US states like California and Illinois is profoundly deflationary. But with a few years’ hindsight we might look back on December of 2012 as the beginning of the chaotic, parabolic stage of the process.

  • transumer

    I have a beginner’s question. I know that the central banks control the interest rate for the bonds they “lend” to commercial banks. Mr. Rubino and others have said that when, “interest rates rise, it will be the begining of the end…”. Are we talking about all of the remainder of a nation’s debt held by everybody else that must be continuously rolled over? In other words, the market portion of the debt whose interest rates are out of the control of the central banks. This seems important but I’m not really clear about it. Thank you.

    • Bruce C.

      Your questions have more complex answers than they otherwise might because of the today’s unprecedented state of affairs.

      First of all, the central banks are not lending bonds to the commercial banks, they are buying them. In the US, the Treasury department issues (Treasury) bonds that the commercial banks (i.e., “the primary dealer” banks) have the exclusive rights to sell to anyone who wants them (i.e,. the Fed, foreign governments, pension funds, hedge funds, financial retail investment houses, etc.). The primary dealers get Federal Reserve Notes (i.e., “FRNs” or US dollars, usually in digital form) in exchange for bond notes written on parchment (the “bonds”) which are contractual obligations, and get to keep a few percentage of the FRNs as sales commissions before depositing the rest in the accounts of the US Treasury.

      Secondly, the interest rates of the bonds bought by the Fed (and I believe all central banks, along with everyone else) are NOT controlled by the central banks per se, they are determined by the market through “open market” transactions with the primary dealer banks. However, as part of the QE3/”Operation Twist” the Fed transacted directly with the Treasury to “avoid paying commissions to the primary dealers”, presumably to not fuel the flames of anger about allowing the “blood sucking vampire squid” banks from profiting from “critical national life saving measures”. (As an aside, China was also allowed to transact with the Treasury directly (sans commission charges) as an incentive to keep buying Treasury bonds).

      Fast forwarding from here to answer your ultimate question …. If or when a central bank buys up all debt then it is “game over”. A financial, macro-economic singularity is reached. It is the point at which all economic activity ceases. Not because interest rates will have sky rocketed but because they will have collapsed to absolute zero. The cost of funds to governments go to zero when their central banks own their debt because all interest payments are returned to the government. Therefore, the actual mechanism for lowering government deficit spending costs is not through interest rates per se via the markets, but by effectively charging zero interest in the form of rebates. The central banks’ balance sheets simply swell inexorably until people stop accepting their monopoly money.

      • transumer

        Thank you Bruce. Like many others, I thought I understood what “credit” and “money” meant. Over the past year, I’ve been self-enrolled in a crash course to figure it out before the real crash occurs. My grandpa told me that one of his strongest memories of the last days of 1929 was that there was not one person in a hundred that understood what was happening and why. It was this confusion that compounded the fear, that became a panic.

  • Agent P

    For the U.S., it really boils down to other countries (slowly, but surely) trading in currencies other than the dollar. No, it doesn’t happen overnight, but it can take place far more rapidly than many care to think – owing not necessarily to economic issues, but foreign policy blunders and increasing animosity among nations who are subject to our foreign policy adventures, while at the same time also forced to utilize the $USD for trading purposes. While we can threaten a handful of ‘patsy’ countries at any given time with a hint or show of carrier-group force, we cannot stop other nations from following a regional leader like China, the Soviets, Malaysia and South America, into trade agreements that circumvent $dollar hegemony. In short, don’t look for a domestically-induced economic implosion brought on by our own profligate waste but instead, keep an eye on what is going on with currency flows outside the U.S. for clues.

    All of this is not lost on our political-monetary leaders, make no mistake about that. They know everything that we do – and more because they are at the center of policy. They’re obviously not too worried, as shown by the circle-jerk that is the ‘fiscal-cliff’ negotiations – which are like pimples on a Tyrannosaurus to begin with, and have almost 0 relevancy to the magnitude of what needs to be addressed in the first place. Where our leaders make their final mistake however, is in presuming that our world currency-military dominancy can continue, unaffected by our increasing $Debts and currency that isn’t backed by Anything…

    • http://theyenguy.wordpress.com/ theyenguy

      Yes, $dollar hegemony is coming to an end, and in its place a Ten Toed Kingdom of Regional Governance will rise to govern mankind’s economic transactions.

      I comment that as Inflationism transitions into Destructionism, the paradigm of global economics is transitioning into the new paradigm of regional economics. Credit Liquidity under Liberalism provided prosperity for many. But as moral hazard has come of age, all of humanity will be booked into Authoritarianisms’ California Hotel of austerity and debt servitude by country leaders, as they meet in summits to announce regional framework agreements, which provide sovereign authority for structural reforms, wage reductions, and the establishment of public private partnerships to manage regional economics, as well as to appoint both a regional political leader, and a regional banking, fiscal and monetary pope.

  • Bruce C.

    JR is exactly right about this currency war insanity being all about governments’ survival (i.e., increases of revenues via taxes), not the well-being of countries, its citizens or small businesses.

    And that is why the next step in this no-win charade are tariffs. If one can’t reduce one’s trade deficits (i.e., imports minus exports) indirectly through currency exchange rates then the next step is to cut-to-the-chase and increase the taxation of imports outright. Of course, that too is self-defeating because the higher retail prices that ensue on imported products tends to reduce retail demand and thus ultimately reduce the tax base of the imports themselves. But as tribalism/”nationalism” hardens, every effort (and risk) will be made to maintain the status quo until either someone else is forced to capitulate or the whole game blows up, which will ultimately amount to the same thing.

    Happily, until then traders can game the game, providing both profits and political media cover to keep the locals angry at all the other countries’ leaders. Personally, I hope it goes fast this time because it can be brutally boring to follow blow by blow. Hopefully, efforts to avoid the “fiscal cliff” domestically, along with efforts to circumvent US dollar transactions internationally may quicken the collapse.

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  • Chris

    What is the meaning of say China, Hong Kong or Singapore governments telling the world that they are pegging their currencies to US$? The meaning is: we are manipulating our currencies.

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  • http://profile.yahoo.com/J75TJPBXVQSCH4NABQB2KNHZ5E Rich

    IMHO, all this is nothing more than debt monetization – plain and simple. Let’s just shift the decimal point two places to the right. Then the debt that seemed insurmountable yesterday is now a factor 100 smaller and quite managle, isn’t it.

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  • andrew hudson

    Firstly- I live in the west. It is absolute hypocrisy of the west to say the Japanese are weakening their currency, the yen, when, as we all know, the US, and uk etc indeed any country who has been engaged in QE and money printing , have been weakening their currency for years. In the meantime, the Japanese made no comment, even though they were contending with no growth, a tsunami, and nuclear disaster. Get real and honest, look at ourselves and actions first, and cut these guys some slack. Absolute hypocrisy!


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