Despite reaching a temporary stalemate, the currency war rages on, and individual countries continue to debate whether they should enter or watch their currencies continue to appreciate. Nowhere is that debate stronger than in New Zealand, whose Kiwi currency has fallen 37% against the US Dollar since its peak in early 2009, and over 15% since June of this year.
With most countries, the war cries are coming from the political establishment, who feel compelled to demonstrate to their constituents that they are diligently monitoring the currency war. This is largely the case in New Zealand, as Members of Parliament have argued forcefully in favor of intervention. Prime Minister John Key is a little more pragmatic: He “says his Government is concerned about the strength of our dollar, but is not convinced intervention would work…politicians who think intervention can happen without economic consequences, are fooling themselves.” Showing an astute understanding of economics, he pointed out that trying to limit the Kiwi’s appreciation would manifest itself in the form of higher inflation, higher interest rates, and/or reduced access to capital.
This is essentially the position of Alan Bollard, Governor of the Central Bank of New Zealand. He has insisted (correctly) that the New Zealand is being driven up, so much as its currency counterparts – namely the US Dollar – are being driven downward, by forces completely disconnected from New Zealand and way beyond its control. Thus, if New Zealand tried to intervene, it would quickly be overpowered (perhaps deliberately!) by speculators. Ultimately, it would end up spending lots of money in vain, and the Kiwi would continue to appreciate.
Mr. Bollard has pointed out that a stronger currency is not without its perks: such as lower (relative) prices for certain natural resources, such as oil. In addition, since New Zealand is largely a commodity economy, its producers are being compensated for an expensive currency in the form of higher prices for milk, wool, and other staple exports. While its other manufacturing operations have been punished by the expensive Kiwi, its economy is still relatively robust. Thanks to a series of tax cuts and the lowest interest rates in New Zealand history, GDP is forecast to return to trend in 2010 and 2011.
New Zealand’s concerns are understandable, and there is an argument to be made for preventing the Dollars that are printed from the Fed’s QE2 from being put to unproductive purposes in New Zealand. At the same time, New Zealand is not such an attractive target for speculators. Its benchmark interest rate, at 3%, is relatively low compared to developing countries. Its current account balance is projected to continue declining, perhaps down to -8%, which means that the net flow of capital is actually out of New Zealand. In addition, while the Kiwi has appreciated against the US Dollar, it has fallen mightily against the Australian Dollar en route to a multi-year low.
Going forward, there is reason to believe that the New Zealand Dollar will continue to appreciate against the US Dollar as a result of QE2 and a general sense of pessimism towards the US. The same is true with regard to currencies that actively intervene to prevent their currencies from appreciating. Still, I don’t think the New Zealand Dollar will reach parity – against any currency – anytime soon, and after the currency fracas subsides, it will probably trend towards its long-term average.
Currency War Will End in Tears
The “currency war” is heating up, and all parties are pinning their hopes on the G20 summit in South Korea. However, this is reason to believe that the meeting will fail to achieve anything in this regard, and that the cycle of “Beggar-thy-Neighbor” currency devaluations will continue.There have been a handful of developments since the my last analysis of the currency war. First of all, more Central Banks (and hence, more currencies) are now affected. In the last week, Argentina pledged to continue its interventions into 2011, while Taiwan, and India – among other less prominent countries – have hinted towards imminent involvement.
Of greater significance was the official expansion of the Fed’s Quantitative Easing Program (QE2), which at $600 Billion, will dwarf the efforts of all other Central Banks. In fact, it’s somewhat ironic that the Fed is the only Central Bank that doesn’t see its monetary easing as a form of currency intervention when you consider its impact on the Dollar and its (inadvertent?) role in “intensifying the currency war.” According to Chinese officials, “The continued and drastic U.S. dollar depreciation recently has led countries including Japan, South Korea and Thailand to intervene in the currency market,” while the Japanese Prime Minister recently accused the U.S. of pursuing a “weak-dollar policy.”
As of now, there is no indication that other industrialized countries will follow suit, though given concerns that QE2 “at the end of the day might be dampening the recovery of the euro area,” I think it’s too early to rule anything out. While the Bank of Japan similarly has stayed out of the market since its massive intervention in October, Finance Minister Yoshihiko Noda recently declared that, “I think the [Yen's] moves yesterday were a bit one-sided. I will continue to closely monitor these moves with great interest.”
As the war reaches a climax of sorts, everyone is waiting with baited breath to see what will come out of the G20 Summit. Unfortunately, the G20 failed to achieve anything substantive at last month’s Meeting of Finance Ministers and Central Bank Governors, and there is little reason to believe that this month’s meeting will be any different.
It’s really just wishful thinking that countries will come to their senses and realize that currency devaluation is self-defeating. In the end, the only thing that will stop them from intervening is to accept the futility of it: “The history of capital controls is that they don’t work in controlling foreign exchange rates.” This time around will prove to be no different, “particularly with banks already said to be offering derivatives products to get around the new taxes.” The only exception is China, which is only able to prevent the rise of the RMB because of strict controls for dealing with the inflow of capital.
In short, the “wall of money” that is pouring into emerging market economies represents a force too great to be countered by individual Central Banks. The returns offered by investing in emerging markets (even ignoring currency appreciation) are so much greater than in industrialized countries that investors will not be deterred and will only work harder to find ways around them. Ironically, to the extent that controls limit the supply of capital and boost returns, they will probably drive additional capital inflows. The more successful they are, the more they will fail. And that’s something that no new currency agreement can change.
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