The G20 summit in Pittsburg reaffirmed the need for a common set of policies to correct global imbalances, and the G7 finance ministers and central bank chiefs, meeting later on in Istanbul, agreed that wild fluctuations in exchange rates harm global economic and financial stability.
However, it is not easy to make exchange-rate adjustments at the same time you’re trying to stabilize them because the two acts contradict each other. I would like to shed some light on several points that ought to be considered when monitoring currency exchange issues.
First, it is only natural for yen appreciation to boost Japanese purchasing power as salaries decline. Finance Minister Hirohisa Fujii did nothing more than point out the obvious when he discussed the benefits of having a strong yen. It is exactly for that reason the United States repeatedly emphasizes the need for a strong dollar, even though it incurs huge current account deficits.
But the foreign-exchange rate is a rate of conversion between two different currencies, and there is no kind of market intervention that pushes up both the yen and dollar at the same time. Fujii’s comment gained attention because it corrected the widely held view — one ingrained in the Japanese mind-set during the export-led recovery that followed the war — that a weak yen promotes economic growth.
Second, recent movements in currency markets should be interpreted more as the fall of the dollar than the rise of the yen. Although the dollar’s decline appears to create a stronger yen on the surface, to know which one is actually causing the fluctuations you have to view the changes via a third currency. Then you will know that this is the fall of the dollar, because the U.S. currency is weakening against both the yen and the euro.
Third, you also need to watch the change in gold — the classic gauge for monitoring currency values. Gold used to be the standard for the international currency system under the Bretton-Woods regime, but its role declined after the 1971 Nixon Shock. Still, gold commands strong trust from the market for its risk-hedging functions.
Recently, gold has been trading above $1,000 per ounce. Its value fluctuates due to various factors, including real demand, hedging demand in times of financial instability as well as its relation to interest rates. Its recent rise is largely attributed to the fall of the dollar.
Fourth is the question of which standard to base your judgment on when determining if the yen is strong or weak.
Even though market rates show the yen is rising, its real effective exchange rate — reflecting the inflation gaps between countries and trading volume — have fallen since the beginning of the year. The lower a country’s inflation rate, the more competitive it is because of the benefits it reaps from lower production costs. When gauged in terms of purchasing power parity, the yen’s value drops further because its land purchasing power is extremely low due to the high cost of land in Japan.
Finally, I would like to offer my long-term perspective on the international currency regime.
The postwar International Monetary Fund regime was based on gold and the U.S. dollar. After a series of developments, including the Nixon Shock and the 1985 Plaza Accord, the dollar saw its exchange rate with the yen fall from ¥360 to less than ¥90.
Still, the world lacks a global currency to take over the dollar’s role. While it is true the dollar now accounts for less than 70 percent of foreign-exchange reserves worldwide, the euro accounts for only 25 percent and the yen a mere 3 percent. For a currency to serve as the key vehicle for international transactions, the economy supporting it must be open, stable and supported by a stable political regime with strong leadership based on a globally common set of values.
Neither the euro nor the yen fulfills these conditions yet. Despite the growing clout of the so-called BRIC economies, their currencies do not meet these requirements either.
Looking back on history, the gross domestic product of the United States surpassed that of the United Kingdom in the 1860s, but the pound continued to be the currency of choice for international settlements and foreign currency reserves for nearly 100 years after.
Despite the rapid acceleration in technology transfers, it takes time to change hearts and minds. Even though it will be haunted by instability, the international settlement system will continue to revolve around the dollar for quite some time.
Teruhiko Mano is chairman of the Mano Economic Intelligence Forum.