“We will refrain from competitive devaluation.  We will not target our exchange rates for competitive purposes…” read the joint statement issued by the finance ministers and central bankers of the G20 over the week-end. 

Pretty clear, right? So, the ‘currency war’ is over (if it ever really began), and we can begin to trust that central bankers will begin to take their duty of preserving the value of their respective currencies seriously?

Unfortunately, as we wrote last week (link), a central banker’s words should not be taken at face value; rather they require careful interpretation before they can be properly understood, modified as they are by subtle semantic tricks used to distract and mislead the less rigorous observer (including, notably, much of the mainstream financial media; the Financial Times, for instance, covered the conclusions of the G20 summit under the headline ‘G20 agrees to avoid currency wars’, a charmingly credulous take on this weekend’s events).

Just as last week we referred to Mark Carney’s insertion of the word ‘flexible’ before the words ‘inflation target’, so that the latter words are rendered virtually meaningless by the former, Carney and his cohorts are it yet again.  Let’s take a closer look at the above statement…

‘We will refrain from competitive devaluation.    

We will not target our exchange rates for competitive purposes’

What the G20 bankers have effectively declared is that, while they promise not to deliberately try and weaken their currencies to gain a competitive advantage, if their currencies happen to weaken while they pursue aggressive and unconventional monetary policies (such as printing money!) for domestic reasons, well, then that is just an unfortunate side effect.

This line of reasoning is reminiscent to that of former US treasury secretary Thomas Connally, who, in the face of European criticism of US monetary policy in 1971, simply responded: “The dollar is our currency, but your problem.”  (The world’s financial elite were not always as subtle and euphemistic as they are today!)

What the G20 are really saying is that, to borrow from military terminology (we are talking currency wars, after all) currency devaluation is akin to what we might call ‘collateral damage’. The United States Department of Defence defines collateral damage as:

“Unintentional or incidental injury or damage to persons or objects that would not be lawful military targets in the circumstances ruling at the time. Such damage is not unlawful so long as it is not excessive in light of the overall military advantage anticipated from the attack[1].”

This military definition quite nicely summarizes the G20’s view of currency wars, or competitive devaluations.  As long as the intent can be justified (monetary policy is based upon domestic economic objectives, rather than an explicit attempt to gain a competitive advantage in international trade), then the consequences (i.e. currency depreciation) are acceptable (and if a country just happens to gain a competitive advantage as a result, well, that’s just a bonus).

As such, the basic argument put forward by the G20 (led by the US, the UK and Japan), is that the ‘gains’ for the world economy (and, therefore, for their respective trading partners) that will accrue as a result of their stimulative monetary policies, such as quantitative easing, will more than outweigh any losses that these trading partners may suffer as a result of relative currency appreciation. 

This argument would make sense, except for one (very important) thing.  The stimulative monetary policies which are being aggressively pursued by many developed economies are not working.  A powerful piece of analysis published by Bill Gross of Pimco[2] earlier this month highlighted the increasing futility of these  policies (which essentially all involve creating credit by lowering interest rates to incentivize borrowing) to boost economic growth:

  • In the 1980s, it took $4 of new credit to deliver $1 of real GDP;
  • Over the last decade, it has taken $10 of new credit to deliver $1 of real GDP;
  • Since the financial crisis, it has taken $20 of new credit to deliver $1 of real GDP.

In other words, quantitative easing (and monetary policy generally) is becoming an increasingly impotent economic tool.  As the Defense Department’s definition makes clear, collateral damage can only be justified ‘so long as it is not excessive in light of the overall military advantage anticipated from the attack.’  And if such polices cannot be justified in terms of domestic economic growth, then surely the ‘collateral damage’ cannot be justified either.

Kevin Lester

Co-CEO



[1] http://www.dtic.mil/doctrine/new_pubs/jp1_02.pdf

[2] http://www.pimco.com/EN/Insights/Pages/Credit-Supernova.aspx