Central bank currency manipulation no panacea, warns Jupiter’s Miles Geldard

Miles Geldard, head of the Jupiter fixed interest and multi-asset team, believes politicians have been placing unrealistic expectations on the capacity for monetary policy to lift their economies out of recession.

Recovery from a major financial crisis such as the collapse of the global credit boom, tends to be weaker and takes longer than recovery from a typical business recession/global downturn. Even though the IMF has come out against excessive fiscal consolidation, politicians have shied away from the traditional Keynesian remedy, i.e. large-scale investment projects to replace “missing” demand because of the already heavy debt burdens borne by their economies. This has placed the entire onus somewhat unrealistically on monetary policy.

When dealing with inflation, central bankers play comfortably on home territory but with deflation they are on away ground. Their success has been variable. In the US, where the Fed has been most active, equity prices have been well supported, the wider economy less so. In the UK, it is an inconvenient truth that the largest Quantitative Easing (QE) programme ever seen singularly failed to prevent the UK from sliding into a double-dip recession. In Japan, the central bank avoided full-blooded QE, barely expanded its balance sheet and kept real interest rates positive with an all-too-predictable result.

Serious changes are afoot in how the world’s central banks conduct monetary policy in the face of persistently sluggish growth. In the US, the Fed now places significantly greater weight on employment than inflation; the incoming governor of the Bank of England, a former co-head of sovereign risk at Goldman Sachs, has mooted a nominal GDP target, while Japan is imposing a higher inflation target on its central bank. In all of the above examples, currency manipulation is the policy that dares not speak its name.

Focus on: Monetary policy and the yen

A closer look at what’s been happening in Japan should prove instructive. Up until recently the yen had been strong for many years. This had caused a hollowing out of Japan’s domestic industry and a loss of global competitiveness. The yen was strong because: Japan ran a trade surplus; the Bank of Japan (BOJ) maintained positive real interest rates against a background of modest deflation; the yen was regarded as a safe haven as Japan stuck to G20 pledges in late 2008 to avoid competitive devaluations; market participants believed the West would not permit Japan to pursue a weak yen policy.

So what has changed? In Japan, the trade balance moved into deficit for the first time in three decades. The change began with a sharp increase in energy imports following the suspension of Japan’s nuclear energy programme after the Great Tohoku Earthquake and subsequent tsunami in March 2011.

This indication of the economy’s fragility led us to be short of the yen in anticipation of it weakening. Many have been bearish on the yen for a long time. Japan indeed has been experiencing modest deflation for some twenty years. A weaker yen was one remedy. We have no crystal ball but took the view that overvalued situations are eventually corrected. It is natural for a country running a trade deficit to reduce that deficit by devaluing its currency and trading partners such as the US have little justification for opposing such a move.

The yen’s first significant fall came in February 2012 after the BOJ adopted an explicit inflation target of 1% when the current inflation rate was -0.1%. The second, more dramatic fall came with the landslide victory of Shinzo Abe’s LDP in December 2012. Mr Abe is determined to push a recalcitrant BOJ for more stimulus. He has doubled the inflation target to 2% and is to appoint a new Bank governor in April. Japan may well use its forex reserves to buy bonds issued by the European Stability Mechanism and euro sovereigns, which would please Europe and temper criticism from the US. The new appointment could also turn out to be as significant as the appointment of Paul Volker to the US Federal Reserve in 1979, which reversed a decade of stagflation.


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