Great Graphic: The Rise and Fall of Currency Wars

This Great Graphic is a result of a query by my colleague Alexandra Jostrom. Using Google search analytic functions, she found there has been a sharp decline in world wide efforts to search for "currency wars".

This dovetails with our long standing argument that "currency wars" were mis-understood, with many observers confusing a metaphor for reality.

The pursuit of monetary policy for domestic purposes cannot be considered an act of war.  Indeed, this is precisely what many of the protagonists--the IMF, the EU, the ECB, the G7 and the G20 have argued. In recent weeks, look at what has happened.

The Bank of England's Monetary Policy Committee overruled it governor and decided not to renew gilt purchases partly for fear it would lead to a sell-off a sterling.  The Swedish Riksbank has told its banks and businesses to get used to a strong krona. The new governor of the Bank of Japan has acknowledged that the 2% inflation target cannot be achieved simply through the exchange rates.

The logic of the currency war framework suggests that euro area was "winning" last July as the euro fell    to around $1.20, the lowest level in a couple of years.   This was a strange kind of victory.  Many were betting that the monetary union was disintegrating.  The euro's decline reflected a capital strike against several countries.  

In this context, we underscore two key differences between now and the 1920s and 1930s.  First, there are circuit breakers, like the World Trade Organization, which act as conflict resolution mechanisms. There was an increase in cases brought to the WTO last year. The increase did not take place in  2010 when Brazil's finance minister first accused the US of starting a currency war by easing policy in an unorthodox fashion when the zero bound was reached, and not in 2011 when other high income countries, also began or expanded unconventional easing programs.

Yet, this does not necessarily mean that the world is closer to a trade war.  Instead, it is a testament to the efficacy of the conflict resolution mechanism and the difficulty being encountered in incorporating China into the world trade system.   

The fact that the international order, for the lack of a better term, is more robust than often recognized is a good segue into the second key difference between now and the 1920s and 1930s.  The main fissure of the global system is not between countries as it was between the world wars, but within countries.

The elites are not looking to preserve their role (or way of life) by taking over territory or taking resources of others.  The elites have been intensifying the pressure on their own people to put the state on more sound fiscal footing. Isn't that what has shaped austerity efforts and the yawning gap between wages on one hand and profits on the other, throughout most high income countries?  

At the same time, we are grounded in realism and recognize that international affairs is commonly the realm in which nation-states pursue their self-interest.  There are exceptions of course,  and there has been a rise of non-state actors, but the recognition of the central role of self-interest is important.

We do see rivalry between countries as significant. However, the international system contains and redirects this rivalry.  The rules of the engagement, as they themselves have evolved in the years since the Plaza and Louvre Agreements, have been for the high income countries to not target currency rates.  Expressing a desire for a weaker or stronger currency is one thing, providing bilateral targets is a different matter.

When Japan seemed to violate these rules of engagement with massive ($100 bln +) intervention in late Oct 2011, it was criticized by its major partners.  Again, more recently Japanese officials were criticized for overstepping the rules and have moved back into compliance.  

Lastly, it is not clear to some why Greece or Cyprus have not chosen to exit EMU.  In currency war terms, they need to fight back.  What the Greek people, Cypriots, Spaniards, Portuguese, Italians and Irish recognize, that apparently many PhD economists don't, is that a currency devaluation is not a panacea.  Greece and Cyprus, for example, do not have the industrial capacity to boost manufactured exports.

What gains in competitiveness might be achieved by a maxi-devaluation would likely be neutralized quickly by higher inflation.  The economy would have both a deep (and arguably protracted) contraction, higher unemployment, and higher inflation.  In addition, the economic crisis has serious social implications, which would potentially limit a surge in tourism that some wishfully project, as well as threaten the privileged position of the elite itself.