Is the IMF in Denial About the World’s Currency War?
With the world on the verge of a currency war, the need for macroeconomic policy coordination among the world’s major industrialized economies has never been more urgent. Yet the IMF, the organization best suited to orchestrate such coordination and whose very mandate is to avoid the recurrence of the beggar-my-neighbor type of policies that blighted the 1930 economic landscape, is conspicuously in denial about the risks of any such war. This has to be regretted since it heightens the dangers of a return to a world of competitive currency depreciation and capital controls that could be harmful to global economic growth and prosperity.
As early as September 2010, Guido Mantega, the Brazilian Finance Minister, sounded the alarm about the dangers of a global currency war. He did so as his country was overwhelmed by a flood of capital inflows that pushed Brazil’s currency into the stratosphere with considerable collateral damage to the Brazilian export sector. He also did so as an increased number of emerging market countries resorted to inward capital controls in an effort to stem the upward pressure on their currencies. Provoking Mr. Mantega’s concern was the resort to highly unorthodox monetary policies in countries like the United States and the United Kingdom as well as the continued resort to currency manipulation by China aimed at preventing any undue appreciation of the Chinese renminbi.
Since Mr. Mantega sounded his alarm, in September 2012 the Federal Reserve announced a third round of aggressive quantitative monetary policy easing and committed the Fed to keeping interest rates at unusually low levels at least until 2015. Not only was this round of quantitative easing to involve large-scale monthly purchases of U.S. mortgage-backed-securities but it was also to be continued until there was a material improvement in U.S. labor market conditions. It is perhaps little wonder then that over the past four months the U.S. dollar weakened appreciably despite the relative outperformance of the U.S. economy over the European and Japanese economies.
The Japan Problem
A more recent cause for concern is the indication of a move to very much more accommodative monetary policy stance in Japan. Bowing to pressure from the new Japanese government, the Bank of Japan has already raised its inflation target and indicated a commitment to open-ended-buying of government securities next year. Anticipating these measures, as well as the prospective appointment of a new Bank of Japan governor, who might be more sympathetic to the government’s view about the need for a looser monetary policy stance, market selling of the Japanese yen has resulted in a 15 percent decline of the yen against the euro over the past two months.
The Japanese yen’s large recent depreciation might presage that something similar will occur to the pound sterling when a change of guard occurs at the Bank of England in June. Mark Carney, the former Canadian Central Bank Governor who has been appointed to replace Mervyn King, is known to be less wed to inflation targeting than was Mr. King. This is all too likely to herald a very much easier UK monetary policy stance that could cheapen the pound.
An indication of the risks that uncoordinated monetary policy easing by the Federal Reserve, the Bank of Japan, and the Bank of England might pose to the global economy is indicated by the more than 10 percent real effective appreciation of the euro over the past six years. As Europe sinks ever deeper into recession and as it perseveres with aggressive fiscal austerity at the time of a domestic credit crunch, the last thing that Europe now needs is a stronger currency that threatens to choke off Europe’s only source of economic growth. Yet this is precisely what might be in store for Europe if the central banks in its major competitors are allowed to continue down an aggressive quantitative-easing path.
The IMF’s Role
In 1944, the International Monetary Fund was created precisely to obviate a return to the beggar-my-neighbor policies of the 1930s. At a time when such policies again appear to be raising their ugly heads, it is inexcusable that the IMF is not providing leadership to secure the multilateral coordination of macroeconomic policies amongst the world’s major economic areas that might prevent a drift towards a full blown currency war. For it would seem that the IMF is best placed to provide an impartial assessment as to the appropriateness of the fiscal and monetary policy mix of its larger member countries as well as an appropriate target zone for these countries’ exchange rates.
This is not to imply that securing effective policy coordination will be an easy task for the IMF. However, it is to imply that failing to secure such coordination runs the very real risk of a further drift to beggar-my–neighbor policies at a particularly vulnerable moment for the global economy.
American Enterprise Institute (AEI) resident fellow Desmond Lachman previously served as director in the International Monetary Fund’s Policy Development and Review Department. He was also a managing director and chief emerging market economic strategist at Salomon Smith Barney.