Two years ago, Brazilian Finance Minister Guido Mantega delighted headline writers around the world by warning that quantitative easing and other stimulative monetary policy measures risked unleashing “currency wars” upon the world. Shinzo Abe’s election in Japan and François Hollande’s worries about the risks of an overvalued euro to the French economy have restarted the drumbeats of currency war. Mantega himself is issuing more dire warnings; Societe Generale foreign exchange strategists are warning that “it’s hard to see what concrete steps can be taken” to halt them; and in the Weekly Standard Irwin Stelzer warns that “Lenin would be cheering the currency wars” as a step on the road to destroying capitalism.
In fact, there’s absolutely nothing to worry about here. At the very worst, the so-called wars that Stelzer and others find so troubling will do nothing at all. At best, globally coordinated, expansionary monetary policy could do a great deal to reduce unemployment in the West and speed industrialization in poor countries.
It’s difficult to even explain what a currency war is, since proponents of the term seem confused themselves, but the basic idea is that central banks and governments are manipulating monetary and fiscal policies to weaken or strengthen the value of their currencies. For example, some currency warriors believe that “QE2” was the opening salvo of an American currency war. QE2, you’ll recall, was a Federal Reserve initiative response to weak growth in the context of low short-term interest rates. Instead of printing money to buy short-term government debt to bring short-term rates down, they printed money to buy long-term government debt to bring longer-term rates down. The goal was to boost the weak American economy. When you print new dollars, that tends to depress the price of dollars relative to other currencies. So the allegation of currency warriors is that QE2 was a covert plot to boost the American economy by depressing the exchange rate. That would make American-made goods cheaper in a global marketplace, thus helping American exporters gain market share while discouraging the purchase of imported goods by Americans.
Net exports are certainly a way monetary stimulus can boost an economy. But where’s the war?
The idea is that my cheaper currency might raise unemployment in your country by hurting your manufacturers. It’s worth noting that it’s by no means obvious that this is true. If fewer Brazilian workers are needed in the Brazilian manufacturing sector, that could mean more workers are available to build proper houses to replace the country’s infamous slums. As a country like China gets richer, we would expect it to have fewer sweatshop workers and more chefs and doctors and teachers providing locally-focused services. A more valuable currency, in other words, can be both a cause and a consequence of getting richer. As formerly poor countries “catch up” with the rich west, it should be no surprise that the value of their money rises relative to that of the dollar or the euro.
Currency effects become a currency war when one country’s depreciation leads to retaliation. Japan’s monetary stimulus devalues the yen, which hurts American and English and European exporters. Then the Bank of England follows suit with its own monetary expansion, devaluing the pound. Now the U.S. and the eurozone are under the gun to expand, reducing the valuing of their currencies with monetary policy.
Real war is negative sum. You blow up my city and I blow up your city, and regardless of who “wins” we’re both short one city and a bunch of bombs. Monetary policy isn’t like that at all. At the very worst, if all the major countries try to expand their currency supplies simultaneously, the exchange-rate effects will even out and nothing at all will happen. More likely, however, we would see positive results—a repeat of what happened during the Great Depression. As CNBC’s Matt Clinch observed, Britain’s 1931 decision to leave the gold standard set off “a volatile chain of events with the U.S., Norway, Sweden, France, and Germany all following suit.” Clinch perversely portrays that as a bad thing. But each country that left gold saw a rapid restoration of growth. Rather than a negative-sum war or a zero-sum balancing exchange, dropping gold and expanding the money supply was a win-win strategy that boosted the world economy.
That’s because currency isn’t just something you can use to buy other currencies with. You can trade dollars for yen, but you can also trade dollars for refrigerators. When currency gets less valuable, stuff becomes more valuable. Households become more inclined to buy durable goods, and firms become more inclined to invest in production equipment. If your economy is facing tight supply-side constraints—you’re out of workers and your factories are already running full-tilt—that just means inflation. But an economy with plenty of extra workers, empty offices, and idle factories will benefit from higher prices because it will be an encouragement to produce more stuff, thereby employing those extra workers. That’s why even though not every country can simultaneously increase its net exports, we can all increase our exports. If we all adopt more expansionary policy, America will export more airplanes and Japan will export more cars and Europe will export more machine tools. Everyone gets more jobs, higher incomes, and more stuff. It’s not a war, it’s a party! Instead of complaining about Japan’s initiatives in this regard, Western governments should be hopping on the bandwagon.