Inside investment: Hobbesian option

Andrew Capon
Published on:

A war of all against all in currency markets will not be pretty. For some countries it may also be too little, too late. The International Monetary Fund has failed in its role as the arbiter of currency values.

Brewer’s Dictionary of Phrase and Fable tells us that Hobson’s Choice means no choice at all. Policymakers in the eurozone and Japan must feel the same as a customer turning up at Thomas Hobson’s livery stable in Cambridge. They have pushed monetary policy to the limit of its effectiveness, fiscal initiatives are still-born due to government indebtedness and structural reform, though worthy, cannot address the exigencies of now. Deflation looms.

Buried somewhere in my memory is the thought that  the primary purpose of the IMF  was to oversee exchange rates. Perhaps that has been forgotten

Having run out of alternatives they have opted for currency weakness to import inflation. This is not Hobson’s choice. It is the Hobbesian option. A weak currency policy brings to mind the state of human nature described by the philosopher Thomas Hobbes in the Leviathan: bellum omnium contra omnes (war of all against all). Emerging markets cannot sit idly by while the world’s wealthiest nations destroy their competitiveness. Everyone is now playing the currency card.

If all currencies are dropping in sympathy there is little point to the exercise, other than creating generalised impoverishment. The idea of coordinated policy – please, you go first – is at best fanciful. But the global economy has an unexpected safety valve, the US dollar. It has risen by around 9% on a trade-weighted basis since the summer.

If the dollar can continue to rise without derailing domestic growth or further undermining inflation expectations, the world will owe the US and the Federal Reserve a debt of thanks. Like everything in economics it is a delicate balancing act. The strength of the dollar is partly predicated on rate rises in 2015. If the Fed did start to fret about the effects of currency strength that could be pushed further into the future. But the dollar weakened by around 20% during the recurrent bouts of QE. There is some headroom.

There is an irony here. Guido Mantega, the Brazilian finance minister, used the term 'currency war’ in 2010. His concern then was that US monetary easing would flood Brazil with dollars looking for carry. He was right as $65 billion flowed into Brazil in 2011, three times as much as the previous year, and the real hit a 12-year high against the dollar that July. It has since fallen by more than 50%.

The case of the Brazilian real is just one example of a profound misalignment of currencies that has been one of the lingering by-products of the global financial crisis. The Japanese yen has weakened dramatically in nominal terms, but only recent weakness has seen it begin to adjust on a real effective exchange rate basis given chronic deflation.

It has taken policymakers a long time to wake up to the potential benefits of currency weakness. The fear is that the damage has already been done and may be irreparable. For a decade up to 2005 the Chinese kept their currency deliberately weak to promote an export-led mercantilist economic policy. Since then the renminbi has risen by 30%.

Many economists now believe the renminbi to be broadly fairly valued on a Purchasing Power Parity basis. It may even suit China to have a fairly valued currency given the current direction of policy is to shift from aggressive mercantilism to consumption-led growth. The Chinese seem to have got what they wanted. Japanese policymakers, on the other hand, are left with a weaker yen not feeding through to the bottom-line of its exporters because they have already off-shored most of their manufacturing.

In Europe the situation is arguably even worse. Imports of cheap Chinese manufactured goods accelerated the hollowing out European industry and shifted income and wealth growth to Asia.

Youth unemployment in the eurozone has barely fallen since the height of the financial crisis

What did the West get in return? Arguably, not a lot: a market of 1.3 billion potential consumers that is dirigiste and closed. China taught Europe a lesson that Jean Baptiste-Colbert, Louis XIV’s finance minister, and a contemporary of Hobbes, would have understood, but somehow got forgotten.

It has been a long time since this columnist lurched from hotel bar to conference room at the annual meetings of the International Monetary Fund and World Bank. But buried somewhere in the memory is the thought that the primary purpose of the IMF was to oversee exchange rates. Perhaps, like Colbert, that has also been forgotten. Or, maybe, it was somehow nodded through that a little bit of currency manipulation was worth it for getting China to sign up to the mores, moral ambiguities and, most importantly of all, the institutions of global capitalism (on their terms).

What seems a small price to pay to the gilded panjandrums of Pennsylvania Avenue, Washington DC, looks different through the eyes of an unemployed Parisian. The statistics are so shocking that they merit constant repetition: overall youth unemployment in the eurozone has barely fallen since the height of the financial crisis and stands at 23%; youth unemployment in Spain and Greece is over 50%; and in Spain one-in-four of the young unemployed are so-called Neets (not in employment, education or training).

These are the true casualties of currency wars. Sadly it has been fought and lost and no one seemed to notice or care. The rise of populist parties in Europe suggests a backlash has begun. The true costs are still being counted.