Commentary: Currency War Goes from Crazy Talk to Remote Possibility

Over the Christmas holidays I spoke off the record with a WSJ reporter about the weakening Yen.  I explained incoming PM Shinzo Abe's platform of pursuing a two percent inflation target, and monetary easing to boost exports and combat deflation.  "Isn't that a currency war," the reporter replied.  No.  Japan's fundamentals had deteriorated, both in the short and medium term.  Japan was back in recession, with GDP contracting 3.5 percent year on year in the fourth quarter.  Government finances were a mess, with debt totally over 220 percent of GDP, and an annual budget deficit of 9.7 percent of GDP.  Japan's declining population, and refusal to admit immigrants also meant that there will be fewer taxpayers to hit up when the fiscal day of reckoning comes.   Furthermore, despite two decades of incredibly loose monetary policy, Japan was still plagued by chronic deflation.  Yet the Yen was near post war highs, fueled by a remarkable demand for so called 'safe-haven' assets amidst European sovereign debt crisis.  (Why the Yen continues to a be safe haven given Japan's bleak outlook is beyond me)  So no, a nudging of the yen downward by signalling out of the Bank of Japan and the newly elected LDP government was no currency war.  It was simply bringing the Yen back into line with the fundamentals when the markets had failed to do so.  

Then the Norges Bank stated that persistent strength of Norway's krone would be a factor in future rate decisions.  Then it was the Euro's turn, with Jean-Claude Juncker, head of the council of EU finance ministers, calling the Euro exchange rate "dangerously high."  These comments were walked back considerably by the ECB's Nowotny, who stated that the FX rate for the Euro was of little concern.  Japan's new government also sent out mixed signals.  Some officials started to express concern that the Yen was now too weak; the LDP secretary general declared that USD/JPY should not rise above 90.  Shinzo Abe was unflapped, redoubling the commitment to his economic program by seeking to appoint a "bold new leader" to head the BOJ when Governor Shirakawa's term ends in April. 

Then Russian central bank deputy governor cried foul.  Alexei Ulyukayev lamented the policy of Yen depreciation, adding further that "Other colleagues from respected central banks and governments already pursue this policy. This is not a path towards global coordination but a separation."  While Mr. Ulyukayev did not use the term currency war, he is the most senior global policy maker to express concern over the recent policy shifts towards weaker currencies coming out of central banks worldwide.  

We are far from the competitive devaluations of the 1930s seen Europe, but a full blown currency war and all its destabilizing effects has move from be unimaginable to remotely possible.