Yen exchange-rate misalignments overstated; renminbi a better focus of currency hostilities

By:
Peter Garnham
Published on:

Much has been made of the recent outbreak of currency war rhetoric, but analysis suggests global exchange rates are not misaligned by historical standards.

The G7 managed to inject volatility into the currency markets on Tuesday with an ambiguous statement that, ironically, warned against excessive volatility in the forex market and called for market-driven exchange rates.

The confusion stemmed from whether Japan was being singled out for direct criticism for its recent campaign to engineer the yen lower to boost its economy, as the G7 affirmed that its members would not target exchange rates.

Leaving aside the implausibility of G7 intervention to stem yen strength, it is worth looking at whether, despite the sharp moves in nominal exchange rates in the past three months, current levels are substantially outside of what could be considered fair value.

That is an exercise undertaken by Credit Suisse, which found little evidence of substantial misalignment.

“While acknowledging the many and varied issues that render point estimates of equilibrium exchange rates difficult to interpret, it is notable to us that against several of the generally used metrics, much less has happened among the major exchange rates than many realize,” says Ric Deverell, research analyst at Credit Suisse.

The most widely used method of tracking movements in exchange rates over time is the real effective exchange rate. Estimates from the Bank for International Settlements suggest little has occurred during the past 30 years

As can be seen from the chart below, after substantial moves towards the end of the Bretton Woods period, the dollar, pound, yen and deutschemark/euro have all moved within a relatively contained range since the late 1970s.

“This suggests that talk of substantial misalignments at current rates is grossly overstated,” says Deverell.

“Indeed, at the risk of over analysis, relative to the 30-year average, the yen is currently around its long-run average while the dollar, the deutschemark/euro and the pound are slightly cheap.”

 Real effective exchange rates relatively stable
 

Meanwhile, purchasing power parity, the other commonly used measure of relative currency value, shows the yen looks overvalued.

 Yen overpriced on PPP basis
 

Neither do trade dynamics suggest the yen is undervalued. Indeed, rather than suggesting increasing trade competitiveness, Japan’s current account has narrowed sharply during the last seven years.

The largest move has in fact been in the eurozone, where the current account surplus has increased to levels not seen since 1985, around the time of the Plaza Accord, which aimed to strengthen the dollar and weaken the deutschemark.

 Current account balances have narrowed 
 

On balance, it would seem there is little to suggest that yen weakness is now excessive by historic standards. Indeed, it would seem, if anything, Japanese officials have been guilty of nothing other than highlighting the fact the yen is overvalued, as purchasing power parity would seem to suggest.

Interestingly, using Credit Suisse’s fair value model, the renminbi is the only currency noticeably undervalued.

That would seem to underline what many have always suspected: China, not Japan, should be the focus of currency hostilities.

 Renminbi only currency undervalued according to Credit Suisse fair value model