Everybody against Japan over yen’s devaluation

The G20 flags. This council brings together the world’s major advanced and emerging economies. (EC Audiovisual Services).

Yesterday, Jörg Asmussen, Member of the ECB’s Executive Board speaking in an interview to a Greek newspaper said, that the issue of the Japanese yen devaluation should be referred to the G7 and the G20 councils. He added that if each-one goes for himself with national currency competitive devaluations, the outcome will be catastrophic for all.

Incidentally the G7 and G20 councils, where the seven and the twenty largest economies of the world agree on some principles on global economic governance, do not have the power to impose policies or economic measures to members. As a result it seems that the entire world is now against Japan, but it is not clear how the other major economies can convince Tokyo to return to its prior position of zero inflation and growth. But let’s start the story from the beginning.

Yen’s devaluation

Central bankers all over the world are warning now against competitive devaluations of national currencies, after the Japanese government appears set to apply relaxed monetary policies, which will have as a direct effect the devaluation of the yen. In this way Japanese products will become more competitive but in a detrimental way for everybody else. In response to that, the other major economies may follow the Japanese way and start devaluing their own currencies, thus triggering a monetary war.

To avoid this prospect the heads of world’s largest central banks appealed to governments to avoid triggering a vicious cycle of devaluations, which may lead not only to trade wars, but also send real markets to a complete disarray, not to say anything about money and capital markets complete disorientation.

Theoretically central banks are supposed to be independent, not accommodating government policies for growth and job creation, with monetary measures. In this respect central banks have as a prime role to control inflation. They are not expected to use interest rate and money supply measures to facilitate development. By the same token they have a gentlemen’s’ agreement between them not to set target for national currency exchange rate as a policy measure. The only acceptable exemptions are the extraordinary measures to fight a credit crunch. Let’s see what happens now in Japan.

Japanese political economics

The Japanese elections of Sunday 16 December changed the political scenery in the country of the rising sun. However the Liberal Democratic Party of Prime Minister, Shinzo Abe, who came to power, was expected by the country’s public opinion to apply an altogether different economic policy to return to growth. The country’s economy in the verge of disinflation had being stagnating for years and the foreign account marked trade deficits after many decades.

In this environment Shinzo started a confrontation with the Bank of Japan (BOJ), the central bank of the country, to raise the inflation target from one to two per cent. He won the battle and BOJ set the inflation target at 2%. To achieve this new inflation benchmark the country’s monetary policy had to be relaxed and Japan was flooded with newly printed yen. As a result the parity of the national monetary unit, the yen, started to devalue in relation with the rest of major currencies.

The devaluation of yen set the alarms first to South East Asia, with China and South Korea complaining, everyday more loudly, about Japan’s monetary devaluation. Actually this was the reason for the Sino-Japanese confrontation over the disputed islands. As the yen continued its downward course making Japanese products more competitive, the US and the European Union are now also feeling the pressure.

Until recently all the major economies of the world were fighting to reactivate their economies. They were following however the general consensus under the G7 council of world economic governance, not to take refuge to currency devaluation, as a means to support internal growth, at the expenses of others. This agreement was largely respected up to the point when the new Japanese government convinced the BOJ to abandon its traditional anti-inflation monetary policies.

Now the rest of the world is trying to convince the new Japanese government to stop using yen’s exchange rate as a national economic policy instrument for growth.