'Refuse to enter any currency war'
- February 16, 2013 - 9:02 PM
Q Why is there a focus on currencies?
A Since the start of the financial crisis, central banks around the world have been trying to stimulate their economies by keeping interest rates extremely low. The goal is to encourage consumers and businesses to borrow and spend more. One way central banks drive down rates is to use their power to print money to buy up large quantities of bonds. But boosting the amount of currency in circulation can drive down the value of that currency relative to others. As a country's currency falls, its exports become cheaper, while those of its neighbors become relatively more expensive.
Japan, the world's third-largest economy, is under the harshest spotlight. To get its economy motoring again after a two-decade bout of stagnation, the government has said it would like to see inflation move higher. Markets have interpreted this as a signal that Japan's central bank is prepared to take actions that would result in driving down the yen, to boost exports and also put upward pressure on prices. Last week, the yen fell to a 21-month low against the dollar and a near three-year trough against the euro.
Q Is Japan trying to weaken the yen?
A Though it's not directly intervening in the foreign exchange markets by selling yen and buying other currencies, comments from the new government have convinced markets that the Bank of Japan will create more money. Finance Minister Taro Aso insists the government isn't focused on exchange rates, but he has noted that the weakening yen has "brought huge benefits."
Q Why is that bad?
A A falling yen will help exporters, such as Sony and Toyota, and boost Japan's economy. And it will it tend to push prices -- and ultimately wages -- higher. But if other countries respond to the falling yen by devaluing their currencies -- to maintain the competitiveness of their own exports -- Japan will be back to square one and the world economy could suffer.
Sharp fluctuations in the value of currencies can hurt business confidence and investment. Prices for imported raw materials and components would be volatile, profits will be hard to come by as prices fluctuate wildly and the value of any investment a company makes in another country could quickly be wiped out.
Q Who's been feeling the effect?
A The euro, the single currency used by the 17-strong group of European Union countries, has seen the biggest move on the foreign exchange markets. As the region moved on from its crippling debt crisis last summer, the euro has slowly gained in value. But since the change of government in Japan, its value against leading currencies such as the yen and U.S. dollar has shot up -- last December it was worth 113.19 yen and $1.29 and now it's at 124.93 yen and $1.33. A rise in the value of the euro will do little to help the eurozone's businesses -- and will hardly help getting it growing.
Q What's been the reaction from other major economies?
A Politicians have voiced concerns about the euro's rise versus other major currencies -- most notably French President Francois Hollande, who indicated he was open to calls for a more managed exchange rate. European Central Bank President Mario Draghi said the bank will monitor the economic impact of the euro's rising value. Several analysts took that to mean the ECB could cut interest rates to bolster growth, which in theory could weaken the euro -- an indirect tit-for-tat response to the yen's fall, some say.
Earlier this week, the volatility in the currency markets prompted the Group of Seven leading industrial nations, which includes the United States, Germany as well as Japan, to warn that volatile movements in exchange rates could adversely hit the global economy. The group reaffirmed its commitment to market-driven exchange rates.
Q How bad could a currency war get?
A Since World War II, one of the key objectives of international economic policymaking has been to avoid a repeat of the 1930s, when countries around the world engaged in a battle with their exchange rates. That decimated global trade, accentuating the depression and providing another catalyst to war. Assuming the world doesn't descend into a similar abyss, a currency war can still harm the global economy. For example, central banks, particularly in the developing world, could resort to controlling the amount of capital that can be moved out of a country to affect exchange rates.
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