With the BoJ and the Japanese government set to announce the now much-anticipated (and oft-repeated rumor) 2% inflation target in a joint (yet, rest reassured completely independent) statement, we have seen JPY swing from a 0.4% weakening to a 0.6% strengthening (sell the news?) and back to middle of the day’s range by the time Europe closed. Cable (GBPUSD) has quite a day, dropping almost 100 pips top to bottom before bouncing back a little. This is 5 month lows for GBP as the triple-dip response of Mark Carney’s new deal starts to get discounted. The USD ended practically unchanged despite all this as European sovereigns leaked wider, CHF strengthened modestly (2Y Swiss positive) and US equity futures did a small stop-run helped by the JPY crosses. It seems the zero-sum game in global FX competitive devaluation, as Steve Englander notes, has a long way to go, for if the UK and Japan, among others, are determined to crowd in growth by boosting exports, their currencies will have to fall a lot more than is now priced in.
Some profit-taking in JPY and GBP taking on the reigns of devaluation to 5-month lows today…
Via Citi’s Steve Englander:
Bottom line is that if the UK and Japan, among others, are determined to crowd in growth by boosting exports, their currencies will have to fall a lot more than is now priced in.
It is often argued that the limited post-depreciation export balance improvement in the UK is due to the concentration of its trade with the euro zone, where growth has been, and is expected by our economists to continue to be, very weak. Were China rather than the euro zone the UK’s major trading partner, the UK’s export performance would be a lot stronger (according to this argument). Similar arguments were made for the lack of response of US exports in the middle of the last decade.
There are two difficulties with this line of argument. First, anchoring yourself 25 miles offshore from China, rather than from the euro zone, is not a policy option, so the UK’s bad hand with respect to export partners still means more rather than less depreciation, if GBP weakness is to be the UK’s growth engine. Second a lot of the UK’s export outperformance versus Europe disappears when you measure export gains in a common currency. So it is possible that the UK export outperformance is linked to translation rather than volume effects.
To gauge this possibility (and see whether it generalizes) we ran an annual regression of the US export price index on the BoE trade-weighted USD index and a couple of lags. When the trade-weighted USD depreciates, you have export prices going up cumulatively by more than 50% of the depreciation over the next couple of years. If you run a similar regression for the UK you have export prices going up by more than 70% of the depreciation in subsequent years. As we know from US (and now Japan’s Nikkei) experience, such translation effects are a marvelous way of making you feel richer, when in fact you are getting poorer. Nevertheless, there is a wealth effect that stimulates domestic demand, the same way that housing wealth does.
However, the specific export volume effect will very likely be much more limited if most of the depreciation shows up as higher local currency prices for exports and, by implication, stable foreign currency prices.
As a footnote, If supply chains are well established and expensive to break, the rational response to depreciation may in fact be to keep prices steady in foreign currencies, and forego any effort to gain market share. This may explain why the export volume response to depreciation globally is much less than advertised in Econ 101, and why currencies often have to move a mile in order for the volume response to become significant.
With this in mind, consider Figures 1 and 2 below which look at UK and German nominal exports to fast-growing countries in local (Figure 1)…
and common currency (Figure 2) terms…
The fast growing economies are Australia, Canada, China, Hong Kong, Saudi Arabia, Russia, Korea, Singapore and Taiwan (the sample was one of convenience and is meant to be non-controversial). UK exports to these countries grow much faster in GBP terms than German exports in EUR terms (Figure 1).
However, the significantly larger post-2007 UK export growth to fast growing countries disappears when measured in a common currency (in Figure 2 we use EUR but relative performance would be unchanged if we used GBP or USD). This does not mean that there is no export volume effect, but as we noted above, the pass through of depreciation into export prices is fairly high, so the volume effects from depreciation per se may be limited. Figure 3 shows how large the UK’s conventionally measured competitive advantage was in 2008-2011. It eroded in 2012 but was still substantial.
Hence our conclusion, that whether you are a Japanese, US or US policymaker, if a weaker currency is going to be the ticket to faster GDP growth, you have to be open to the possibility that you will need lots of it. You end up with a currency war, not because depreciations have such a big impact on activity, but because you need a big depreciation to get any significant impact.