Walker's World: New currency wars

By MARTIN WALKER, UPI Editor Emeritus  |  Feb. 4, 2013 at 12:07 AM
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PARIS, Feb. 4 (UPI) -- Ten years ago this week, one British pound bought 1.6 euros. Today it buys 1.15 euros, which means British exports are dramatically cheaper and Britain's imports from Europe (and British vacations in Europe) are very much more expensive.

There could hardly be better news for Britain's beleaguered exporters and the shift in exchange rates helps explain why the country's car manufacturing broke all-time export records in 2012, with more than 1 million cars sent overseas out of the 1.5 million made.

And with some $10 billion of new investments in the pipeline from Nissan, BMW and Jaguar-Land Rover, production should top 2 million in 2016. It is noteworthy that this performance took place against a dramatic fall in car sales in Europe, with last month saw 15 percent drop in French registrations to their lowest January level since 1997. Italian sales dropped 17.6 percent.

By contrast with Britain, auto manufacturers in the United States are nervous at the effect of lower prices for Japanese imports after the sharp fall in the value of the Japanese yen. Last October, just four months ago, one dollar would buy just less than 78 yen. Last week, a dollar bought 93 yen, close to a 20 percent drop, and the yen has fallen even further against the euro.

Welcome to the new era of currency wars. Three years ago, Brazil's finance minister warned that this would be coming as he saw Brazil's manufacturing industry shrink under the impact of Brazil's soaring real and the flood of cheaper imports from abroad. China's efforts to hold down the value of its own currency have triggered repeated fits of outrage in Congress.

There are three bizarre features of the global currency markets. The first is that they are huge, regularly trading in a range of $4 trillion-$5 trillion a day, which means that ever year they are trading more than $1 quadrillion, which is about 13 times the value of all the economic activity on planet Earth.

The second curiosity is that currency values are sometimes far adrift of economic fundamentals. There are reasons for the current weakness of the British pound and of the Japanese yen but they don't justify the massive swings in currency value.

It isn't easy to explain, on the basis of comparative output figures, why the euro should have been worth just more than $0.84 in 2000 and then became worth $1.60 in 2008. The value of the two economies didn't diverge to anything like that extent; Europe didn't become twice as prosperous nor did the United States shrink by half. (The dollar is currently trading at $1.36 to the euro.)

The head of Germany's Bundesbank, Jens Weidmann, sounded a warning last month on the implications of latest currency gyrations, although he didn't use the incendiary term "currency wars." Instead he spoke of "competitive devaluations."

"Already alarming violations can be observed, for example in Hungary or Japan, where the new government is interfering massively in the business of the central bank with pressure for a more aggressive monetary policy and threatening an end to central bank autonomy. A consequence, whether intentional or unintentional, could moreover be an increased politicization of exchange rates," Weidmann, who also sits on the ECB's Governing Council, said in a speech to the German stock exchange. "So far the international currency system has come through the crisis without a devaluation competition, and I hope very much that remains the case."

Weidmann's fear is that competitive devaluations are a form of protectionism in disguise, as governments seek to boost their own exports by making them cheaper.

This brings us to the third oddity of exchange rates: that such efforts can only last if other governments allow competitors to get away with it. Once they start taking action (whether through lowering interest rates or changing tax codes or fiscal policies) to devalue their own currencies they join a race to the bottom which nobody can win. The effect could be like the protectionist wars of the 1930s.

The point is that currency markets overreact. The prospect of the United States falling off the fiscal cliff last month, or facing a further political crisis over the deficit this spring, means the markets have been worried about the value of the dollar. But the decision of Shinzo Abe's new government in Japan to lower the exchange rate by targeting higher inflation and more borrowing has hit the markets even more.

There is no such logic behind the shifts in Europe between the pound and the euro. The latest British manufacturing data and the Purchasing Managers Index are both better than their European counterparts. The euro crisis isn't over and a new banking scandal in Italy and the latest uproar over Spanish politicians and secret funds are destabilizing the politics of the eurozone.

What made the markets sell pounds and buy euros was that Britain's relatively decent data were expected, while minor blips in the eurozone PMI and its unemployment rate came as a surprise.

For British exporters this was helpful. For British voters however, whose pounds now buy less while the government admits that its latest welfare cuts will push 200,000 children below the official poverty line, the prospects are grim. The currency markets giveth and they also take away.

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