At the end of last year, Japanese Prime Minister Shinzo Abe fired a loud salvo. In a forceful attempt to kick start Japan’s economy from its decade-long stupor, Abe leaned on the Bank of Japan to set a 2% inflation target. He threatened to pass a law to limit the central bank’s independence if it balked. “Countries around the world are printing more money to boost their export competitiveness,” said Abe. “Japan must do so, too.” The Bank of Japan caved, vowing to step up purchases of government bonds starting next January.
Then Abe went a big step further by nominating Haruhiko Kuroda to the top post at the Bank of Japan. Kuroda, who is likely to be approved as early as this week, has been the highest-profile critic of the Bank of Japan’s conservative monetary policies for years. According to many analysts, Kuroda’s nomination confirms that Abe is serious about injecting significant new liquidity into the system to help stimulate Japan’s economy and reverse deflation. Such moves also apply downward pressure on a nation’s currency.
The Prime Minister’s actions immediately set off alarm bells. To many, Japan’s announced plans, which already have driven the yen to its lowest level since 2009, looked like the spark that could ignite a global currency war — a series of competitive devaluations that, last century, helped plunge the world into the Great Depression. Jens Weidmann, president of Germany’s central bank, warned that Abe’s strong-arming of the Bank of Japan could lead to “increased politicization of exchange rates. Until now, the international monetary system has come through the crisis without a race to devaluation, and I really hope that it stays that way.” Central bankers from the U.S., Britain, Russia, South Korea and elsewhere added to the chorus about global currency policy.
Meanwhile, at the G-20 meeting in Moscow in mid-February, attendees soft-pedaled the threat. Japan’s currency depreciation is the result of domestic monetary policy, not explicit exchange rate targeting, they concluded. “The talk of currency wars is overblown,” said International Monetary Fund (IMF) managing director Christine Lagarde during the meeting. “There is no major deviation from the fair value of major currencies. The international financial system can work if each of its members follows the right policies for their economy.”
Wharton finance professor Bulent Gultekin, a former governor of the Central Bank of Turkey, agrees that there isn’t yet cause for alarm. “It’s a very different world now,” he says, noting that the Great Depression was the unique outcome of multiple factors, including the end of World War I, pressures on the British pound and the decline of the gold standard. “That was a period when nations tried to outbid each other through competitive devaluation. Those ‘beggar-thy-neighbor’ policies led to tariffs and import restrictions impacting international trade. That was the real problem, unlike today.”
Originally published in Knowledge@Wharton, March 13, 2013.