Analysts and officials have warned about a global currency war for a long time. With the Bank of Japan announcing an unlimited easing program, this war has entered a new dimension.
“When you have too much debt, it’s jamming up balance sheets, it’s shutting down commerce, shutting down credit, you don’t have enough growth, so currency wars arise,” says James Rickards, author of the bestselling book “Currency Wars.”
According to him, central banks and governments across the globe have been taking turns to cheapen their currencies against each other. “When you have a world economy that doesn’t have enough growth, countries are tempted to steal growth from their trading partners by devaluing their currency,” says Rickards.
With its announcement on Jan. 22 to provide open-ended easing, the Bank of Japan now has joined the global currency war. The Japanese central bank will start buying 13 trillion yen ($145 billion) worth of government securities starting in January 2014.
In December 2013 the current asset purchase program of 76 trillion yen ($860 billion) will run out. Ten trillion yen will be spent on purchasing lower maturity bills and around 2 trillion will be spent buying longer dated Japanese government bonds.
Once implemented, the program does not have a set timeframe. Instead, Japan aims to achieve a target of 2 percent annual inflation for the country’s consumer price index, which has been flat or declining for most of the past decade.
Another less explicit goal is to weaken the exchange rate of the yen versus the dollar and the Chinese yuan. Japanese industry giants such as Sharp have lobbied for a cheaper yen to make the country’s exports more competitive.
Policy Response Triggers Policy Response
According to Rickards, this move by the Japanese comes in the wake of the United States starting the currency war in 2010 with the aim to devalue the dollar and boost exports with the second round of Quantitative Easing by the Federal Reserve.
“Bernanke gave a speech in 2002. When you are at the zero bound interest rates you are not at the end of monetary easing, you can still create monetary easing by devaluing the dollar. You import inflation from abroad; the only problem is that our trading partners have wanted to maintain the value of the dollar. We want to cheapen it, they want to keep it the same,” says Rickards.
After the Fed started Quantitative Easing, virtually all other central banks around the world have at least kept pace and expanded their balance sheets by printing money and buying up different assets.
According to research by Kyle Bass of Hayman Capital, the big four central banks (People’s Bank of China, Federal Reserve, European Central Bank and Bank of Japan) have expanded their balance sheets by over $10 trillion over the last 10 years. Their assets now make up 25 percent of global GDP, up from 10 percent in 2002.
“As investors, what do we think about the quadrupling of central bank balance sheets to over $13 trillion in the last ten years? It certainly doesn’t make me feel any better to say it fast or forget that we moved ever so quickly from million to billion to trillion dollar problems,” writes Bass in a letter to investors.
While asset purchase programs were initially restricted either by a fixed timeframe or a limited number of purchases, the Federal Reserve, the European Central Bank (ECB) and the Bank of Japan have now moved to unlimited buying programs.
The Fed is buying $85 billion of government bonds and mortgages each month until the unemployment rate drops below a certain level. The ECB said it will buy an “unlimited” number of shorter term bonds of troubled eurozone nations if need be in order to preserve the euro.
Given a recent calm in European bond markets, the activation of the ECB program so far has not been necessary. The ECB has pumped $1.3 trillion of liquidity into the banking system via so-called Long Term Refinancing Operations, thereby drastically increasing its balance sheet.
The People’s Bank of China never had a limit on money printing in the first place. Throughout the decade, it needed to keep printing yuan and buying dollars in order to keep the exchange rate with the dollar at an artificially low level.
“[Brazil or China] maintain a peg. And the way they do that, is they tell the exporters, you gotta hand over your dollars and we are going to give you local currency. That means the faster we print dollars, the faster the foreign central banks print their local currencies to soak up the dollars and the inflation rates go up over there,” Rickards explains this phenomenon.
The Bank of England, despite not having announced an unlimited program yet, is likely to move in a similar direction. The bank’s Chairman Mervin King told the press Jan. 22, “The Bank of England is ready to provide more stimulus if needed.”