Those pundits that insist on framing the issue in the foreign exchange market as a currency war appear to have been given much fodder this week. According to an unnamed French official, US President Obama began the week by complaining about a strong dollar at the G7 meeting. Then was BOJ's Kuroda's comments about the yen that saw triggered an immediate and sharp reaction in the foreign exchange market. Today is was comments by Merkel that triggered a quick half cent or more loss in the euro.
Of course, one needs to ignore the fact that the White House and Obama personally denied such comments. It does not appear that Obama was complaining about the dollar's strength but the lack of aggregate demand elsewhere, and perhaps cautioning against relying on exports to the US, instead of structural reforms at home.
One needs to also ignore the fact that rather than talking the yen down, Kuroda suggested that on a real effective basis, it was difficult to see much more yen weakness. The yen rallied strongly in response. What kind of currency war is that?
Merkel's comments today are less inflammatory than the initial headlines read. This is not the first (nor will it likely be the last) time that Bloomberg went with a headline that was misleading and/or taken out of context. Its modus operandi seems to be first with the headline and then later release rest of the story.
Merkel's reportedly said that when countries "that have undertaken considerable reforms like Portugal, Spain, Ireland -- but especially Spain and Portugal -- find themselves in a global environment in which a very strong euro means that they can harvest the fruit of the reforms only with great difficulty, including in the area of exports, then I do want call for understanding when a central bank like the European Central Bank thinks about what you need to do when the inflation rate is so low."
The German Chancellor appears to be explaining what happened. She is not making a claim of what ought to take place. This Great Graphic, from Bloomberg, shows the BIS calculation of the euro's real broad exchange rate. Merkel's reference to "a very strong euro" clearly does not apply to current conditions. Indeed, the BIS data, which is only through this past April, shows that this important economic measure of a currency, places the euro near the lows set in 2000. It is well off its highs from a year ago. Since the end of April, the euro is slightly higher against the US dollar (0.4%) and a little more against the Chinese yuan (~0.5%), but (~2%) lower against the British pound and the Swedish krona.
We are well aware that international relations is characterized by broad competition between nations. That competition pervades various dimensions of economics and politics. However, there is also cooperation. We have suggested that just like in military matters there are arms control agreements, we suggest there is an arms control agreement in the foreign exchange market. Countries can pursue beggar-thy-neighbor currency devaluations, but they have agreed to forgo this MAD (mutually assured destruction) approach. Despite some flirtation with violations, we think this arms control agreement remains intact, even after this week's flurry of official comments.
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