A currency war is inevitable in the era of quantitative easing (QE). While the long-standing assertion by major central banks that the exchange rate is not a policy tool is pretty much true, there is a well-understood link between monetary policy and the strength of a currency. It is no mystery that the market expects a currency to depreciate each time the monetary authority in control of the particular currency decides to expand its policy.

So, just because the exchange rate is not a policy tool does not mean these central banks are not involved in a currency war. The truth is that it only makes their participation in such so-called war indirect. These central banks have been accused of weakening their currencies through the back door even as they maintain a free-floating exchange rate mechanism.

The need for QE is not being disputed here. The world is stuck in an extraordinary situation where any typical monetary policy is simply inadequate. Rates are so low that it cannot be lowered anymore. QE easily circumvents that problem.

The need for weaker currency for certain countries is also not being disputed here. Time is so bad in the developed world that, almost everybody there wants to export their way out to prosperity.

Currency depreciation does increase the competitiveness of a country by making its exports cheaper to the rest of the world. The issue is that nobody can have a weak currency all at the same time. A currency is always valued against the rest. Someone out there will always suffer from a stronger currency. It is a race to the bottom so to speak.

Under normal situation, the tit-for-tat policy can be disastrous. Economists have a special name for that: beggar-thy-neighbor  Add in concerns for hot money inflow and asset inflation, emerging economies are ill at ease with ever looser monetary policy in advanced economies.

But then again, are the QE and the implicit currency war that follows really that bad in this time of extraordinary circumstances?

The world’s economy requires some kind of rebalancing. Notwithstanding the debate on fiscal austerity in Europe, there is a need for the developed world to spend less and save more, and they may need to export more and import less.

This is the very opposite of what is mostly required by many emerging countries, which do save too much and continue to be export-dependent. The dependency maybe untenable in the near future since most exports go to the very economies that are struggling to grow in the first place. There is just not much room for exports to grow anyway.

For Malaysia, there has been some kind of rebalancing. While the national economy continues to rely heavily on exports, domestic demand has played an increasingly bigger role in moving the economy forward.

Despite uncertainty in the global economy, Malaysia has grown at a rate that is largely surprising in the past few quarters. The fourth quarter national GDP numbers will be released soon and the figures will likely show an uninspiring export growth in contrast to a relatively strong domestic demand growth.

Strong domestic demand translates into strong import figures. In fact, the contrast between global demand of Malaysian goods and services and domestic demand has been spectacular. Malaysian exports for 2012 did not grow more than 1% from the year before while imports grew by nearly 6% in the same period. It is really a wonder that Malaysia maintains a trade surplus still.

Before anything, it is good to know that at least 20% of imported goods and services in 2012 originated directly from countries which unambiguously run a QE programme. Three of those countries are the United States, Japan and the United Kingdom.

These two facts, the first being strong import growth and the second being a large chunk of it is coming from the big three advanced economies engaging in QE, highlight at least one benefit of the currency war: the continuing depreciation of those currencies has kept Malaysian imports cheaper than it would have been otherwise.

This is especially relevant since Malaysia is embarking on massive investments which include the construction of mass rapid transit lines. These efforts require considerable imports of goods the domestic industries are incapable of supplying.

Furthermore, the federal government does have a role in financing these projects in one way or another. It is very possible that the growth of government expenditure has been limited by a stronger ringgit, which has allowed for cheaper imports. That also means it limits the size of fiscal deficit of the federal government, which has come under intense public scrutiny in recent times.

So from this perspective, the supposedly currency war between the big economies is not that bad. While some measures against hot money and asset inflation may be called for, this is a show Malaysia should sit back and enjoy.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
First published in The Sun on February 14 2013.

Trackback URI | Comments RSS

Leave a Reply