Since 2009, the world’s major economies have quietly tried to get one over on one another by using central bank policies to undermine the value of their currencies. A 25% slump in sterling in 2009 helped the UK through the worst of the recession. Japan’s post-2012 revival has been helped greatly by the slide in the yen under ‘Abenomics’.
In 2014, when he was still barred from doing quantitative easing (QE), European Central Bank governor Mario Draghi assisted troubled eurozone nations by talking down the euro. And even the Federal Reserve largely managed to keep a lid on the dollar until the middle of last year. So it shouldn’t be that much of a surprise that China has finally joined the ‘currency wars’, allowing the yuan renminbi to weaken drastically this week.
There’s plenty of debate over whether China is making its currency more flexible so as to secure the yuan a bigger role on the global stage, or if it’s simply a ploy to boost flagging growth. But this is largely irrelevant. The reality is that China’s economy is slowing, partly because it can’t compete with the likes of Germany and Japan at current exchange rates. Investors realise that. So in the absence of support from China’s central bank, this may well be just the start of a longer decline for the yuan.
The problem is that currency wars are a zero-sum game. As two of MoneyWeek’s favourite analysts, Russell Napier and Société Générale’s Albert Edwards have noted, a weak Chinese currency will export deflation to the developed world (by making imports cheaper), even as central banks struggle to push inflation to anywhere near their target levels.
For example, before this week, all the market could talk about was when the Fed will raise interest rates. But the strong dollar is already biting into the earnings of S&P 500 companies, which make much of their money overseas. Meanwhile, the weak oil price is hurting the shale industry, one of the big US success stories of recent years. So how keen will the Fed really be to raise rates? If deflation returns, expect “another financial crisis as policy impotence is soon revealed to all”, warns Edwards.
That’s scary enough. Yet policy impotence might be the least of our worries. Labour leadership hopeful Jeremy Corbyn, with his idea of a “people’s QE”, has revived debate over more radical monetary policy options, including printing money to pay for infrastructure development, or even crediting people’s bank accounts directly.
In 2009, the idea of printing money to buy government bonds seemed unthinkably radical. But if we face another global recession with interest rates at today’s levels, we’ll find out just how much more radical central bankers can get. I have a nasty feeling that they might stretch our existing monetary framework to breaking point – and beyond.