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Halushka Olena Mykhaylivna, Taras Shevchenko National University of Kyiv, Institute of International Relations postgraduate student, International Business Department E-mail: [email protected]
Reserve currency devaluation and its impact on the global economy
Abstract: The goal of this research is to analyze the preconditions and consequences of the change of exchange rate of national currencies of the USA, Japan, EU, and China which occurred after the global financial crisis. The impact of competitive devaluation of reserve currencies on the small economies and the entire global economy is assessed in this paper.
Keywords: reserve currency, devaluation, monetary policy, quantitative easing.
Although for more than a century the countries have been actively using devaluation as a monetary and financial instrument to gain the advantages, especially to increase the volume of national exports, reduce imports, and improve their standing in the global market, this instrument started to be widely used only after the global financial crisis in 2008. It is explained by the fact that the recession and the decline of the financial sector of the developed countries and a few developing ones have reached such a rate that traditional ways of overcoming the crisis are no longer effective. Therefore, these countries started to devaluate their national currency. Devalua-
tion of reserve currency has an impact not only on the national economies of the countries-issuers, but also on the global economy, as this currency is used in the international transactions, the issue of investments and credits, formation of foreign exchange and gold reserves, etc.
Competitive devaluation is closely connected with the trade and customs wars and is aimed to:
— gain the advantages in the international trade by means of making domestic products cheaper, whereas the imported ones — more expensive;
— create favorable conditions for the development of domestic production and protection of domestic producers;
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Reserve currency devaluation and its impact on the global economy
— reduce the government’s debt burden by buying out debt obligations for a reduced price.
The global currency war started after the global financial crisis of2008-2009. It is a serious threat to the global growth and cooperation, as devaluation can be beneficial only in case one country is devaluating its currency with relation to the currency of another country. However, when all the countries devaluate their currencies simultaneously, everyone loses, as the foreign trade processes are disrupted, and the global economic growth slows down.
The present-day Jamaican currency system is based on the principles of free convertibility of national currency and floating exchange rates. Before this system was introduced, the global foreign exchange market had been dominated by the United States of America. During the epoch of Bretton Woods agreement (from 1944 to 1978) the U. S. dollar functioned — along with the gold — as a global currency. The U. S. dollar had a fixed value against gold. The Jamaican currency system has abolished the gold standard and maintained the parity of the currency.
Nevertheless, as a matter of convention and due to the fact that the U. S. Federal Reserve System had led the expansionary monetary policy, the American currency has remained the most convenient payment instrument, which helped the USA maintain its standing as the world’s largest economy and biggest financial center. Actually, the USA has acted as an initiator and one of the key players in all three currency wars — in 1921-1936, 1967-1987 [1, p.41] and 2010-2014.
Recently all of the world’s largest economies have been involved in the currency war, and the governments of these countries understood that such actions pose a threat to the global economy. Thus, ministers of finances and heads of the central banks of G20 members met in Moscow in February 2013, having decided in the result that the member countries shall refrain from devaluating national currencies in order to gain competitive advantages.
However, the summit resolution, whereby the exchange rate shall be established by the market, not by the government, offers no guarantees to such countries as Brazil whose high interest rates attract foreign investments, which increases the value of
national currency and, thus, makes exports more expensive.
At the same time, U. S. Federal Reserve chairman Ben Bernanke said that the United States was using devaluation to advance domestic objectives. The Japanese representative also insisted that the Bank of Japan’s pledge to start buying unlimited amounts government bonds was purely to help its shrinking economy get out of recession. The ministers agreed there was nothing wrong with such policies [2]. However, the line between devaluation to advance domestic objectives and devaluation to gain competitive advantage is very thin, and there are no mechanisms to distinguish between them yet.
The movement in the yen/U. S. dollar exchange rate proves that Japan cannot be called ‘a currency manipulator.’ Figure 1 shows that since the Plaza Accord was signed in 1985, the value of yen has not decreased, but only increased. Slight devaluations have been used as a modest correction of foreign exchange rate. Thus, in September 1985 the exchange rate was 237 yen per U. S. dollar, while in February 2014 it was only 102 yen per U. S. dollar.
Japan has not brought about the latest economic crisis, but it has suffered from it more than other industrial countries. It is confirmed by the analysis of statistical data of the country’s GDP growth. Thus, in the peak of2008 crisis, the GDP of USA dropped by 0,3%, while in 2009 it continued to decline, having reached the level of 2,8%. At the same time, the GDP of Germany increased by 1,1% and declined by 5,1% in respective years, whereas the GDP ofJapan dropped by 1% and 5,5% respectively [4].
The yen’s rise from 2008 to 2012 has deepened the recession in Japan. The Japanese currency has risen in value in this period owing to the fact that the Japanese creditors, worried about the crisis of substandard crediting in the USA and unstable situation in Europe, repatriated a part of their investments which they used to channel abroad and decided to invest their money into more reliable Japanese economic entities. Therefore, it was risk minimization that boosted the yen’s rise during the crisis.
Moreover, the currency management of the U. S. Federal Reserve System and the European Central Bank helped to strengthen the Japanese yen and bring the Japanese investors back to the domes-
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tic financial markets. In the post-crisis period these financial institutions have considerably lowered the interest rates. Thus, the U. S. real interest rate has dropped from 5,2% in 2007 to 1,2% in 2011, in Euro area the interest rate was 4% in January 2008, slightly increased to 4,25% in July-September 2008, and dropped to 1% in May 2009. Actually, Japan
was the only country with increasing real interest rate — from 2,8% in 2007 to 3,8% in 2010 [8]. Due to inflation, real interest rates were either negative as in United Kingdom or very low as in the U. S. or Eurozone, which inflicts losses on investors. In this situation a large part of the burden of monetary policy falls on currency.
Figure 1. Exchange rate of the yen against the U. S. dollar, yen per U. S. dollar [3]
Consequently, the currencies of both the USA, and EU have lost in value compared to the Japanese currency due to the significant increase of public-sector debt in the result of measures taken to support the market environment, implementation of the policy of cheap money, and granting financial aid to the banks to save them from bankruptcy after the crisis. It is only recently, after the situation in Euro area has started to stabilize, that Japanese investors are again investing in euro. However, the fact that the yen’s rise started back then, when the interest rates in euro and U. S. dollars considerably exceeded the interest rates in yen (2007-09), suggests that a significant capital outflow should not be expected.
From October 2012 to February 2014, the yen has lost in value against the U. S. dollar by 29,17% [3], against euro — by 35% [5]. Although the Japanese market is not a major target marker for the European and American companies, the Japanese companies are their competitors in the global market. For that reason rapid devaluation of yen provokes questions and criticism of the governments of those countries.
In autumn 2012, Brazil’s finance minister Guido Mantega claimed that new rounds of ‘quantitative
easing’ launched in the USA and Japan would only exacerbate global currency wars and make other countries reciprocate by the same actions. He made this claim after the U. S. Federal Reserve System launched QE3 program, nicknamed as ‘QE3-Infin-ity’, which allowed the Federal Reserve to purchase assets for $85 billion per month of commercial housing market debt risk.
The dollars created in the result of several rounds of ‘quantitative easing’ are the banknotes not backed by gold reserves which circulate not only within the country, but are also used by the USA to buy foreign goods, pay off the external debt, and invest in other economies. Moreover, U. S. dollar is a global reserve currency, so this country has a powerful instrument of influencing not only the domestic economy or economy of its partners, but also the entire global economy. The countries manufacturing goods or supplying raw materials will incur losses compared to those who create key measure ofvalue for foreign trade and controls these processes.
However, since December, 2013 the U. S. started to decrease a pace of quantitative easing. Beginning with August, 2014, the U. S. Federal Open Market Committee started to add to its holdings of agency
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mortgage-backed securities at a pace of $10 billion per month rather than $15 billion per month, and longer-term Treasury securities at a pace of $15 billion per month rather than $20 billion per month [6], and in October 2014 the program was ended. This makes U. S. dollar becoming stronger.
But after the third round of ‘quantitative easing’ was launched in the USA, the Bank ofJapan initiated an extended program of asset purchase and crediting for 10 trillion yen, which should have finished in December 2013, but in April 2013 was replaced with even more extended program of buying out government stocks of all maturity terms to increase the monetary base by 60-70 trillion yen per year up to reach 270 trillion yen by the end of 2014 [7].
The countries of Euro area, especially France, responded to such actions of the USA and Japan. Before the summit in Moscow in February, the finance minister of France Pierre Moscovici has expressed his concern that increase of euro’s exchange rate makes the goods of Euro area less competitive. Moscovici called on the European Central Bank to set the limit of euro’s exchange rate increase. The president of France Francois Hollande stressed that markets are not to be expected to determine the value of euro, when the trade partners of the EU pull down exchange rates of their currencies to make their products more competitive. He claimed this taking into account the strengthening of euro: from July 2012 to February 2013, when this claim was made, the exchange rate of euro was increasing, having reached its 15-month maximum rate against the U. S. dollar — slightly more than 1,36 U. S. dol-lar/euro on January 28, 2013. However, euro’s exchange rate to U. S. dollar did not drop rapidly in 2013-2014 due to the lack of firm stimulation measures in the EU currency management, and it remained at the level of 1,28-1,38 U. S. dollar/euro.
Due to devaluation of reserve currencies, dynamically developing economies find themselves in the risk zone. Economic growth indicators of these countries are more compelling than similar indicators of developed countries: for instance, Brazil’s GDP growth rate in 2008 totaled 5,2%, in 2009 it dropped by 0,3%, but in 2010 increased by 7,5%. In 2011 Brazil’s GDP growth rate reached 2,7%, while in 2012 it slowed down to 0,9%. The real inter-
est rate in Brazil during this period fluctuated from 35,9% to 30,2% [8].
Confidence in the currency of developing countries has always been low. Therefore, many governments and heads of central banks of these countries take measures to stimulate the economy and raise confidence in the national currency. In particular, they issue loans in this currency on attractive terms and offer higher interest rates for the national currency deposits than for foreign currency ones. This situation might stimulate the inflow of risk capital to the country, which, in its turn, might lead to the rise in the exchange rate. However, it is a rare phenomenon under the conditions of economic and political instability, as the investors face high risk. Moreover, the governments of developing countries often resort to currency issuance to cover the current needs, which accelerates the inflation rate. Thus, for the last couple of years most currencies of developing countries have lost in value against the U. S. dollar.
To maintain the exchange rates of their currencies under such conditions, the developing markets should obviously either reduce the interest rates or take protectionist measures.
On the whole, the developing countries responded to the launch of the third round of ‘quantitative easing’ by the U. S. Federal Reserve System more calmly than to the start of its second round. Thus, the governments of the South Korea, Thailand, Singapore, and Philippines stated that they were ready to interfere, should the inflow of capital become threatening. After that the U. S. dollar index against a basket ofkey international currencies has dropped by 18% for 13 months starting from June 2010.
China is a major player in the currency war. It is almost the only country that has been using competitive devaluation for a long time and still enjoys its positive results. Although starting from 2005 China has been conducting gradual revaluation ofyuan, as of September 2013 its foreign currency and gold reserves totaled 3,66 trillion U. S. dollars, which a number of experts consider a consequence of a long-lasting undervaluation of Chinese currency.
Over recent years, especially after the onset of the global economic crisis, the Chinese leaders have been publicly criticizing the monetary policy of the
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United States of America as such that cannot maintain the stability of U. S. dollar as the world’s reserve currency. China has again called for deamericaniza-tion of the world against the backdrop of the public management crisis in the USA in October 2013.
In this context it should be mentioned that China is one of the largest foreign holders of U. S. debt. Beijing holds U. S. treasury bonds for 1,28 trillion U. S. dollars and considers this asset as one of the possible ways of investing the country’s foreign exchange reserves. Therefore, China is closely watching the domestic situation and foreign policy of the USA, as devaluation of the American currency might incur direct and considerable economic losses to this country. And it is due to the regular fluctuations of U. S. dollar exchange rate that China more and more often declares its intention to make yuan the world’s reserve currency instead of the U. S. dollar.
Under the post-crisis conditions, the developed countries use devaluation of the national currency to overcome the recession, because other instruments prove ineffective. It is almost impossible to distinguish between devaluation to overcome the impact
of the economic crisis and devaluation to gain competitive advantage in the international trade.
The countries issuing the world’s reserve currency own a powerful instrument of influencing not only their national economies or the economies of their partners, but also the entire global economy. The value of foreign currency and gold reserves of other world countries depends on the exchange rate policy of the developed countries. In case of devaluation the countries manufacturing goods or supplying raw materials will in long term incur losses compared to those who create key measure of value for foreign trade and controls these processes.
Due to the devaluation of reserve currencies, dynamically developing economies — new industrial countries, as well as developing countries, find themselves in the risk zone. Economic growth indicators of these countries are more compelling than similar indicators of developed countries, while interest rates are usually higher, especially considering the fact that in the post-crisis period in the developed countries they come close to 0%. The inflow of risk capital into such an economy might heat it up and lead to the rise in the exchange rate.
References:
1. James Rickards. Currency Wars: The Making of the Next Global Crisis. Penguin Books Ltd, USA. 2012.
2. Jan Strupczewski. Analysis: G20 promises unlikely to end devaluation debate. Reuters. Available at: http://www.reuters.com/article/2013/02/16/us-g20-devaluation-idUSBRE91F05S20130216. Access on: 16.02.2013.
3. Bank ofJapan. BOJ’s Main Time-series Statistics (Monthly). Available at: http://www.stat-search.boj. or.jp/ssi/mtshtml/m_en.html
4. The World Bank. GDP growth (annual%). Available at: http://www.worldbank.org
5. European Central Bank. Euro foreign exchange reference rates. Japanese Yen (JPY). Available at: www. ecb.europa.eu/stats/exchange/
6. Federal Reserve System. Press-release of the Board of Governors of the Federal Reserve System. Available at: http://www.federalreserve.gov/newsevents/press/monetary/20140730a.htm. Access on: 30.07.2014.
7. Leika Kihara. BOJ to pump $1.4 trillion into economy in unprecedented stimulus. Reuters. Available at: http://www.reuters.com/article/2013/04/04/us-japan-economy-boj-idUSBRE93216U20130404. Access on: 4.03.2013
8. The World Bank. Real Interest Rate,%. Available at: http://data.worldbank.org/indicator/FR. INR. RINR?page=1
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