Currency wars: Victory to countries with the weakest currency

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After touching a bottom level on the 3rd of May at 105.54 yen, the dollar has resumed and is now close to 110 yen, helped by comments from FED members that interest rates in the United States could be raised at the next meeting mid-June.

USDJPY technical wedge pattern: Daily evolution of the pair.
USDJPY technical wedge pattern: Daily evolution of the pair. © forexop

Background

On the 20th and 21th of May, the finance ministers and central bank governors of the G7 met in Sendai in Japan in preparation for the 42nd edition of the G7 summit, to be held on Thursday 26th and Friday 27th in the area of Ise-Shima in Japan. This weekend, Tokyo had hoped to obtain agreement from its partners to counter the recent increase of the YEN, which is weighing on exports and by extension on its economy.

G7 members “stressed the importance for all countries to avoid competitive currency devaluations”.

Japan and USA: divergences on currency policies

At the ministerial meeting of the G7, Washington highlighted the importance for global economic stability not to intervene on the foreign exchange market to curb the appreciation of a currency. By contrast, several members of the Japanese government, such as Taro Aso, Japanese Finance Minister, and Haruhiko Kuroda, governor of the Japanese central bank, have recently declared to be ready to intervene in the foreign exchange market if the YEN continues to strengthen.

Washington believes that the recent increase in the YEN does not justify government intervention in the foreign exchange market. G7 members “stressed the importance for all countries to avoid competitive currency devaluations”. But Taro Aso reassured on Tuesday during a parliamentary session that the “Japanese government has no intention of further lowering the currency to boost competitiveness and absolutely no intention of devaluing the YEN in a sustained manner” (Bloomberg).

What is a Currency War?

Reminder: a competitive devaluation, also known as a currency war, represents a situation in which a central bank decides to manipulate its currency to make it weaker in order to boost the competitiveness of its economy.

Competitive devaluations

The exchange rate may depreciate against other currencies, or in relation to a reference currency, or a basket of currencies. Weak domestic growth in some countries make their economies more dependent on exports as it is easier for foreigners to buy products from a country whose currency is cheaper. This decrease in the exchange rate versus foreign currencies allows supporting exchanges to revive growth and rebalance their trade balance.

A country that has strongly devalued its currency strengthens its economy at the expense of other countries

In addition to improving exports, competitive devaluation makes imports more expensive for its residents, which pushes households to consume “homemade.” The domestic industry is boosted, allowing a virtuous circle of economic growth by consumption, which also improves employment and by extension public revenues. However, the competitive devaluation penalizes foreign investors holding government bonds and shares in the country.

A country that has strongly devalued its currency strengthens its economy at the expense of other countries, which creates an imbalance in world trade and can cause a general weakening of currencies since other countries will be tempted to devalue their currencies in turn.

Japan and competitive devaluation: an “excessive” rise of YEN may justify government intervention

Japanese Finance Minister Taro Aso said this weekend that “in line with previous commitments of the G7 and G20, stable exchange rate was extremely important because excessive and disorderly movements penalize the economy.” Japanese exports continued to decline for the 7th consecutive month in April as shown in the figures published on Monday.

Particularly affected by the appreciation of the YEN and a sluggish external demand affected by the slowdown in emerging economies, exports were down 10.1% year-on-year in April and down 7.6% to China, Japan’s main trading partner. This figure underlines the growing challenges of the efforts from the Japanese Prime Minister, Shinzo Abe, to boost economic growth in Japan through the establishment of the 3 arrows present in its economic policy package (Abenomics).

The dollar has recently strengthened with the expectations of higher Fed Funds rate by the FED this summer.

Although Washington thinks otherwise, the Japanese government finds movement in the YEN “excessive and disordered” and wishes to intervene in the foreign exchange market to curb the recent rise in the YEN. The dollar was trading around 110 YEN last Friday at the beginning of the G7 meeting. The USD/YEN fell below 106 a few weeks ago (a 12% fall since the beginning of the year till this bottom level).

The dollar has recently strengthened with the expectations of higher Fed Funds rate by the FED this summer, especially after the release of the April FOMC minutes. The accepted level for the USD/YEN is settled around 109 yen, according to Taro Aso.

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About the Author

Carolane de Palmas After graduating with a Masters in Corporate Finance & Financial Markets and getting the AMF Certification (Financial Markets Regulator in France), Carolane went to market analysis software company (Highwave360) to take part in the European launch of their new market analysis software (stocks and currency pairs). She then become an independent trader, investing mostly in European and American stocks and indices (CFDs) using macroeconomic and technical analysis.

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