Mises | 31 May 2016
Last month, central bankers and finance leaders from the Group of 7 (G-7) advanced economies met in Sendai to discuss the global economy at large. As expected, the United States cautioned Japan, a US currency watchlist country, to refrain from taking further steps to manipulate its currency. This warning came as a result of finance minister Taro Aso hinting that his country was “prepared to undertake intervention” in the foreign exchange market in order to weaken the yen.
The hypocrisy of US Treasury Secretary Lew’s injunction is laughable. He might as well have told Japan, “We’re America, we’re powerful, and we’re allowed to make rules that we’re allowed to break,” because that was certainly the implication of his words.
Historically, the US has been the world’s leading cheerleader for currency manipulation. Not only has the US encouraged and aided Japan in its quest to keep the yen’s value low, but it has also mimicked Japan’s own export-friendly monetary policy in times of panic.
What Is Currency Manipulation?
Currency manipulation is essentially when a country artificially weakens the value of its currency to increase its net exports. This can be done in one of two ways:
- By purchasing foreign currencies in the exchange market to increase their buying power.
- By using dovish monetary policy to increase inflation, cut interest rates, and reduce domestic purchasing power.
Suppose it takes 100 Japanese yen to purchase 1 dollar. Also suppose that the Japanese government is unhappy with export totals and wants to sell more goods to the United States. The Japanese opt to “fix” this through Path A: they purchase billions of dollars with their currency, increasing the supply of yen on the market and decreasing the supply of dollars. As a result, the yen depreciates in value, moving the US-Japan exchange rate to 110:1.
Translation: Americans can now purchase Japanese goods for fewer dollars, while US goods have become increasingly expensive for the average Japanese citizen.
Alternatively, the Japanese could have chosen Path B and simply printed more yen. The increased supply of yen would have led skeptical investors to sell Japanese bonds and stocks and purchase foreign ones, hence shrinking the yen’s buying power.
In either case, the underlying objective is achieved — US consumers begin purchasing more Japanese goods because they can afford more for less.
The Effects of Devaluation
Is currency manipulation a sound economic policy? Absolutely not. The Japanese are essentially subsidizing cheap goods to the United States. It is true that the wealthier owners of the Japanese export industries may profit from the increase in sales, but the cut in purchasing power has to affect someone. In this case, it harms the Japanese workers, who, in the absence of a pay raise, are subjected to declining real incomes.
Of course, currency manipulation also distorts the structure of production, and meddling with the labor market is never a good thing. Exchange rate intervention has caused Japan to gain a disproportionate amount of manufacturing jobs and the US to gain a disproportionate amount of service industry jobs. These market distortions are troubling for both sides, because comparative advantage in the global economy would certainly be higher overall in the absence of government intervention.
From a holistic standpoint, currency manipulation isn’t great for either side. But it is hypocritical for the United States to rail against Japan for considering further exchange rate interventions when the US itself has been a leading participant in the global currency wars.
Japan Has Helped the US Devalue
Historically, the US — a sucker for cheap imports — has encouraged the yen’s devaluation and has even helped in financing its decline. For example, from September to October 2003, Japan sold 2.7 trillion yen in order to devalue its currency. Japan’s Ministry of Finance confirmed that much of it was purchased by the United States through the New York Federal Reserve.
In some cases, however, the US has found its own currency to be too strong. In such cases, it has intervened in the foreign exchange market to devalue the dollar, even receiving assistance from countries like Japan in doing so.
This occurred in 1997 to 1998, when the dollar’s purchasing power increased against the yen by nearly 15 percent. In an effort to combat its rapid appreciation, the New York Fed purchased over $800 million worth of yen. As you can see in the chart below, from December 1997 to June 1998, Japan was not the one artificially lowering its currency. The country was actually strengthening the value of the yen by selling tens of billions of dollars in order to help the US devalue its currency:
And so, if the US government wants to continue dishing out anti-currency manipulation rhetoric, it best explain why it’s had its own hands in the foreign exchange market.
The US’s Huge Quantitative Easing Devaluation
But the US doesn’t just manipulate its currency through Path A. It does so through increasing its money supply far more often. The most memorable example of this in recent memory came during the heat of the 2008 financial crisis. With millions of lost American jobs, Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson were desperate to boost US GDP in any way possible. They did so by manipulating the currency through dovish monetary policy, cutting the federal funds rate and then immediately beginning the infamous quantitative easing program.
From November 2008 (the beginning of QE1) to June 2011 (the end of QE2), the M2 money stock increased by over 1 trillion. Not surprisingly, this expansion of the money supply contributed to the dollar-yen spot rate plummeting from 96.89 to 80.49 during that time frame:
And what came with a declining US-Japan spot rate? Skyrocketing US exports of goods to Japan, of course:
While the spot rate began to increase shortly after QE2 as a result of Japan’s own extensive monetary easing, the point remains clear: the US used the power of the printing press to manipulate its currency downward in a clear attempt to artificially increase net exports.
The Yen Rallies
Thankfully, countries can’t manipulate their currencies forever. The jig has to stop sometime, and Japan’s economy is a case in point to this fact. The Japanese economy isn’t doing so well these days. The country, which is dependent on exports, can’t seem to weaken the yen with respect to the dollar. In fact, the yen recently reached its strongest position against the dollar since October 2014.
Japan is running out of options. Its interest rate is currently sitting at -0.1 percent, so it would be hard pressed to weaken itself through a further expansion of the money supply. Its only other recourse is to intervene in the foreign exchange market for the first time since 2014, which is why finance minister Taro Aso recently insinuated that his country may soon look to do so.
Although further currency manipulation is far from ideal, the US is in no place to criticize Japan for it. With the dollar as the de facto world reserve currency, the US shouldn’t govern like a playground bully, nor should it lead with a “do as I say, not as I do” mantra. It should either lead by example or sit down and shut up. But the sooner it chooses the former, the sooner the practice of currency manipulation will stop completely; and the sooner some degree of fiscal sanity will be restored to the global economy.