It seems that over the past few months, central banks from all over the world have been posturing for a potential clash, as they have taken on various measures towards weakening their respective currencies. However, two major economies have become more active as of late. Will their actions trigger the start of a global currency war?
The Demise of the Yen
Let's start by setting our eyes to the east, where Japan has been stuck in a battle with the yen.
Shinzo Abe, a former Prime Minister who was voted back into office because of dissatisfaction with the last leadership, has been implementing an aggressive set of policies aimed at breathing life back into Japan's ailing economy.
With hopes of ending Japan's deflationary problems and promoting business activity, Abe has put together a $117 billion package to boost government spending on public infrastructure and disaster recovery, as well as lend aid to small businesses.
Taking Abe's lead, the Bank of Japan has adopted some bold moves of its own by recently announcing open-ended purchases of government bonds and doubling its inflation target to 2%.
Needless to say, these aggressive moves have really done a number on the yen, which explains why the Japanese currency has lost so much ground over the past few months. As of this writing, the yen has lost about 20% of its value against the dollar since USD/JPY bottomed out in September 2012. Against the euro, its performance has been even worse, as it's down about 25% from September levels.
However, the yen's rapid decline hasn't gone unnoticed by other countries, which is why concerns of a global currency war have been reignited.
The Meteoric Rise of the Euro
In contrast to the yen, the euro has been one of the strongest currencies in the last couple of months as the fears of a financial meltdown in the euro zone continue to subside. EUR/JPY is now sitting at 125.50, over 3,000 pips higher from its lowest point in 2012.
Unfortunately, the euro's strength is making Europe's exports more expensive in the global market. This could potential hurt the competitiveness, and therefore growth, of the euro zone nations. It has also alarmed the European Central Bank (ECB), as it thinks that it may be a major setback to its inflation goals. ECB President Mario Draghi made mention of this in the central bank's most recent interest rate statement.
Draghi, in response to the persistent strength of the euro, has assured the markets that the central bank has no plans of engaging in a currency war as the strength of the euro merely reflects the renewed confidence of the market in the euro region. Nevertheless, market participants remain doubtful. If the euro continues to climb, the ECB may have to retaliate whether it wants to or not.
What should the central banks do now?
I think it's pretty clear that policymakers aren't aiming to depreciating their respective currencies. The rise and fall of their currencies are simply the effects of their own domestic monetary policies rather than deliberate weakening.
What these central banks need to do now, I believe, is communicate with each other to avoid unwanted exchange rate volatility. Of course, this is easier said than done as each nation has different needs. In Japan, the key focus is stoking inflation. In the euro zone, the main focus is keeping banks solvent and economic growth.
For now, all we can do is wait. The G20 meeting is coming up--perhaps we can get some clues as to what the world's major economies are planning with regards to the appreciation or depreciation of their currencies.
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