The Plunging Euro and Its Muddled Cheerleaders

Greg Ip had a couple of pieces on currency wars and gyrations in the Wall Street Journal last week (here and here), essentially arguing that talk about currency warfare is much beside the point and that exchange rate gyrations are merely benevolent side-effects of monetary policies that will inevitably make the whole world better off. The Financial Times had an editorial on the ECB’s QE and the euro plunge that ran along the same lines, bluntly declaring that “any criticism from outside the eurozone that the fall in the single currency will kick off a global currency war [was] misplaced.” And Bloomberg summed it all up by proclaiming that the whole currency war talk is a “load of baloney,” fearing that the currency war nonsense talk might lead to trade restrictions, which would do real harm.

While the Financial Times sees no cause for alarm at all it seems, Greg Ip’s alarm bells would only go off if China were to retaliate by weakening the renminbi.

So there appears to be a consensus that all is currently for the best in all possible currency worlds. As ever so often, the consensus may be seriously off track here.

Consider Greg Ip’s main point, which is that monetary easing cannot do any harm by weakening a currency because it simply forces other central banks to follow suit, which eases the global monetary stance, which is all for the good. Well, the argument fails to distinguish situations in which all countries share common monetary policy requirements from situations in which that is not the case. The former kind of situation prevailed right after the Lehman bankruptcy, when the Federal Reserve’s easing provided the scope for a global monetary easing. This benevolent alignment didn’t last very long, however, as the U.S. monetary stance proved to be excessively easy for numerous countries in the emerging world — countries that may today be held back by the financial fragilities that were created at that time. Fast forward, recovery in the U.S. appears to be leading the world economy today, creating the opposite kind of challenges. So is the Federal Reserve prodding everyone else to tighten too, to the benefit of the world? Or are the ECB’s QE adventures prodding the Federal Reserve to change course, to the benefit of the world and the U.S.? If neither is the case, will the resulting exchange rate gyrations really benefit the wider world — unless China devalues its currency, that is?

The new consensus overlooks that it matters to the global economy whether important countries are mainly driven by domestic demand growth or mainly freeload on net exports.

The evolution of current account imbalances and contributions of net exports to GDP growth in the key countries featured in talks about currency wars is revealing.

The U.S. had persistent negative net exports GDP growth contributions and a rising current account deficit prior to the crisis of 2008-09. The crisis then halved the U.S. current account deficit. And post-crisis QE and dollar depreciation saw U.S. domestic demand growth stimulate (disappointingly meager) U.S. GDP growth while net exports made a broadly neutral contribution as the U.S. current account deficit was contained overall. Suffice to mention that U.S. energy production was an important swing factor in this outcome. The U.S. non-energy external balance has deteriorated with the U.S. recovery.

Japan ran huge current account surpluses prior to the crisis. As the favored carry-trade currency, the yen was cheap at the time. When crisis struck, the yen appreciated sharply at first, and Japan’s current account imbalance has since disappeared as net exports made negative GDP growth contributions in the last four years. More recently, the yen’s appreciation was partly reversed by means of QE starting in 2013 when the Japanese authorities also initiated a program to stimulate domestic demand.

The eurozone had a broadly balanced external position prior to the global crisis. Internally, however, diverging competitiveness positions led to huge imbalances, which then imploded. As the eurozone authorities’ policy response suffocated domestic demand, positive GDP growth contributions from net exports were the currency union’s only lifeline. The eurozone has a surging current account surplus, the biggest in the world today, with Germany and the Netherlands as the lead stars.

It is true that China had by far the biggest current account surplus prior to the global crisis. But China has also gone through by far the biggest rebalancing since. China’s current account surplus halved in absolute terms; in relative terms it plunged from 10 percent of GDP to roughly 2 percent within a short period of time. In fact, the country has experienced quite persistent negative GDP growth contributions from net exports since the crisis.

In essence, in the years since the global crisis, China was the number one global growth engine, while the eurozone was the world’s outstanding drag on growth, undermining a proper recovery. Germany’s bilateral trade and current account balances vis-à-vis China are in surplus today.

The latest monetary policy initiatives and currency gyrations should be read against this background. The consensus suggests that euro devaluation through the ECB’s belated QE is just fine, a measure for the general good of the world. Apparently the plunging euro is not designed to augment and sustain the eurozone’s freeloading on external growth; it is not the mechanism by which the eurozone exports its homemade mess to innocent bystanders. By contrast, as Greg Ip states explicitly, if the Chinese authorities were to devalue the renminbi, that could be seen as beggar-they-neighbor policy, an attempt to steal demand from their trading partners. Apparently, China is obliged to provide positive growth stimuli to the global economy and must not try to contain the damage that eurozone freeloading has on its development.

Surely Dr. Schäuble and Germany’s export industry can only applaud the new consensus. Never mind the shallow double standards on which it rests. Or do we all begin to adopt the kind of logic that prevails in Dr. Schäubles “parallel universe”* — making it yet another German export success?

* Back in September 2013, Dr. Schäuble famously suggested (see my comment) that critics of the brilliant eurozone crisis management undertaken under his stewardship were living in a “parallel universe where well-established economic principles no longer apply.” Eurozone crisis management has been so brilliant that the world now enjoys its fruits at a super-competitive euro exchange rate. Bravo! More cheerleading please.