Surviving the currency competition

by Shinji Fukukawa

The yen’s exchange value is considered likely to top the rate of ¥79.75 to the dollar registered in 1995 for an all-time high sooner or later. At a meeting that ended Oct. 23, Group of 20 finance ministers and central bank governors managed to contain the confrontation between the advanced economies led by the United States and the major emerging economies including China, and agreed for now to avert a global competition of currency devaluation.

But the exchange markets are accelerating the trend of flight from the dollar due to concerns about U.S. employment uncertainty and credit crunch. And the Federal Reserve Board has stepped up its credit-easing measures, adding further momentum to the dollar’s decline. In addition, the Democratic Party’s heavy losses in the midterm election reflect the American people’s distrust of the party and President Barack Obama. Consequently, confidence in the U.S. economy is being seriously shaken.

Meanwhile, China flatly refuses to appreciate its currency despite U.S. pressure apparently because of its fears that the renminbi’s appreciation might cause its economy to fall into a slump, which could trigger social unrest. It is not surprising that the U.S. government, anxious to double its exports as a strong lever to achieve national economic recovery, is strongly dissatisfied with the attitude of the Chinese government.

Presumably because of this background, at the meeting of G20 finance ministers and central bank governors in October, the U.S., together with conference chair South Korea, proposed numerical targets to limit current-account deficits and surpluses to within 4 percent of gross domestic product by 2015.

The G20 joint communique stated that the participants vowed to pursue all conceivable policy measures aimed at “reducing excessive imbalances and maintaining current-account balances at sustainable levels.” Later, the G20 leaders who attended the November summit agreed that the “persistently large imbalances” in current accounts will be measured by “indicative guidelines” to be determined later.

Judging from the developments at the October G20 meeting, I would like to make two points:

First, expansion of the framework for currency coordination from the Group of Eight to the G20 has made it difficult to attain agreement. This is a clear indication of the instability of the global governance mechanism. The situation has resulted from the fact that whereas the U.S. remains unable to play a leading role in the process of coordination, the growing economic clout of the major emerging economies, including China, India and Brazil, is allowing them to be more assertive.

As the global economy accelerates its shift to a multilateral structure, more countries are joining the management of the world’s economic order, making the work of agreement formulation difficult. Accordingly, participants in this process are strongly urged to show a sincere attitude to respect the value of global benefits, but politically it is not easy.

Second, it may be difficult to halt the competition to devaluate currencies despite the G20 October agreement. The U.S. seems unlikely to take any drastic action to rectify the decline of the dollar. European countries are aiming to improve their financial structures. Britain and France in particular are endeavoring to reduce fiscal spending and raise taxes. But they cannot ignore the importance of expanding exports to achieve economic recovery.

China, facing the problems of expanding gaps in incomes and regional economic wealth, may continue to reject external pressure to let the renminbi rise. India and Brazil will find it unavoidable to restrict the inflow of funds because of their fear that raising interest rates to check economic overheating may result in a large increase in the entry of funds.

Some people may term this string of developments a “currency war.” The current unstable situation is likely to persist unless the world can find a new and workable growth model.

The Japanese government intervened in exchange markets in September in an attempt to stem the rise in the yen’s value. But as had been anticipated, the interventions turned out to be effective only temporarily. It is not necessarily certain whether market intervention has become impossible due to the accord made at the October G20 meeting. But if Japan should go its own way to carry out market interventions again it will surely come under strong international criticism.

What is important for Japan’s policy development is to promote down to earth and steady growth policies. As long as the current deflation spiral continues, consumption and investment will not gather momentum. The fundamental way to expand consumption is to take steps to encourage corporate activities and expand employment, instead of carrying out “money-splashing” measures such as child allowances.

To this end, Japan should promote regulatory reforms and improve the environment surrounding businesses. If it wishes to pin hopes on the growth of the medical service and health sectors, their competitive environs need to be improved in such a way as to help them stand on their own as industries. If it wants to use the curbing of global-warming gas emissions as a means of putting the economy on the right track for growth, it should stop relying on the restrictive cap-and-trade system and instead adopt the method of providing incentives for technological innovations by setting targets for such innovations.

In addition, Japan must reduce its corporate tax rates, which are higher than those of many other countries. Tax preferences for investment promotion and expansion of experiments and research must also be boosted. It is worthwhile to study a new system to give preferential tax treatment to corporations that have improved their employees’ share of company income.

Concerning how to address the proposed Trans-Pacific Partnership, which is designed to promote tariff-free trade expansion, the Kan Cabinet is obviously trying not to miss the bandwagon. This policy issue is increasingly becoming a source of conflict in the Japanese political arena. It is necessary for Japan to step up moves to join TPP negotiations.

In the past, this country lagged behind its major neighbors in working out and implementing effective policies for free trade agreements. As a result, it now stands at a disadvantage in external trade competition with countries such as South Korea.

There are no surprise tactics in dealing with the problem of the strong yen. Policy priority should be given to measures that encourage consistent efforts at innovations and globalization of business.

Shinji Fukukawa, former vice minister of the Ministry of International Trade and Industry and president of Dentsu Research Institute, is now chairman of the Machine Industry Memorial Foundation.