Over the weekend, many market commentators expressed relief over the pledge by finance ministers of the Group of Twenty (G20) countries and heads of central banks to refrain from competitive devaluation, from targeting the exchange rate for competitive purposes and to resist all forms of protectionism. This was a lofty sentiment, no doubt. The surprise for financial markets was that there was no naming and shaming of Japan by the other 19 for its policy of yen debasement—whether explicit or implicit. The yen price of the US dollar has gone up from 78 to around 94 in the past four months. On the face of it, this was statesmanlike behaviour by the G20 group. They had an opportunity to open the door for blatant beggar-thy-neighbour policies by blaming each other but chose not to do. Is that the right interpretation? With advancing age comes a certain cynicism. Bare Talk does not think that altruistic or broader considerations were behind G20 restraint. In fact, G20 countries are likely to be disloyal to their pledges.
Japan was merely the last to follow a monetary policy for domestic considerations, which has, as its collateral consequence, a dramatic weakening of the yen against other currencies. Criticizing Japan will make other countries, particularly the US, a legitimate target for other G20 members. Brazil has already been vocal about the spillover effects of the expansionary monetary policies pursued by G7 countries. The US has committed to exceptionally low interest rates for a long time and has expanded its asset purchase programme. Before Japan (or, China, for that matter) can be accused of currency manipulation, the US deserves the tag of a currency manipulator. Hence, the G20, in effect, did not exercise the option of charging the US with competitive devaluation.
Y.V. Reddy, former governor of the Reserve Bank of India, has always taken the stance that countries should be free to pursue policies suited to their domestic priorities. Hence, he was as understanding of China’s exchange rate management as he is of the current monetary policy of the US. Of course, that is an appropriate stance for a policymaker lest he opens himself to external criticism when he pursues policies in pursuance of domestic economic goals but which have spillover effects. What has happened at the G20 meeting is analogous to Reddy’s stance. It legitimizes policies pursued in domestic interest irrespective of their global impact save for the ritualistic reference to monitoring and minimizing the negative impact of spillover on other countries (para three of the communiqué at http://en.g20russia.ru/load/781209773).
As usual, financial markets are celebrating an outcome that actually opens the floodgates for policies ostensibly targeted at domestic circumstances but that have regional and global spillover effects. This communiqué raises the risk of competitive currency debasement in the months ahead. China has reasons to be pleased with the outcome of this G20 meeting. Contrary to popular perception, this meeting did not help strengthen the global financial and economic situation. Hence, investors’ decision to dump gold is unwise. The spot price of gold dropped $57 per ounce last week. In the short term, the market reaction is always superficial and wrong. Eventually, investors see things in the proper perspective. Therefore, Bare Talk is clear in his mind that the sell-off in gold last week was both exaggerated and wrong and will be happy to use the price drop to increase his exposure to the yellow metal.
What does it mean for the yen outlook? It is customary in the financial marketplace to buy the rumour and sell the fact. That might happen for the Japanese yen. It has weakened substantially in the last four months. Since the G20 has refrained from censuring Japan, it has implicitly sanctioned a similar conduct on the part of others. Hence, further yen weakness might be slow to come and is not necessarily preordained.
Bare Talk had written thrice on the yen and global currency games in 2012—once in March and then in November. The second occasion was in October when we commented on the outlook for the Australian dollar and the increasing concern in that country over the strength of the currency. The two columns on the yen focused on the income side of the effect of a weaker yen. For the most part, a weaker yen adversely affects the purchasing power of the ageing Japanese household. However, there is the asset angle to the equation. Japan has a large net positive international investment position. It is 60% of its gross domestic product. Hence, a weaker yen translates into a higher yen value of Japan’s international assets. If the wealth effect dominates the income effect, Japanese households will be better off rather than worse off with a weaker yen.
If Japan turned the corner faster than either the US or the Europe, expect the next G20 communiqué to strike a different posture.
V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at email@example.com.
To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk