A RETURN TO BEGGAR THY NEIGHBOR ? / THE WALL STREET JOURNAL ( HIGHLY RECOMMENDED READING )

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SEPTEMBER 24, 2010.

A Return to Beggar Thy Neighbor?

By RICHARD BARLEY

Beggar-thy-neighbor currency devaluations proved ruinous for the global economy in the 1930s. Is the world setting off down the same slippery slope again?


Japan's decision to intervene in the currency market to drive down the value of the yen blew a hole in the developed world's united effort to persuade China and other Asian countries to stop artificially holding down their currencies. Meanwhile, speculation that the U.S. and U.K. could soon resume quantitative easing has hit the value of the dollar and sterling. The resulting tensions are bad news for the euro zone but a gift to gold bugs.

The good news is that interventions have been aimed more at containing currency strength than inducing weakness, and with limited success. The impact of the Bank of Japan's initial two trillion yen ($23 billion) intervention already is fading: The dollar is back below 85 yen, although the risk of further sales of yen remains.


Similarly, the Swiss National Bank's efforts to contain the rise of the Swiss franc haven't stopped it from gaining 13.4% against the euro this year. Some emerging markets, such as Brazil, while acknowledging the need for currency appreciation, also have threatened to intervene to prevent sharp moves.


The risk is that the lure of beggar-thy-neighbor competitive devaluations, in which one country institutes to gain at the expense of its trading partners, may increase if the U.S. and U.K. embark on further quantitative easing. For central bankers, one of the happy byproducts of printing money is that it helps drive down the value of the currency. The Bank of England has welcomed the sharp decline in sterling since late 2008. Federal Reserve Chairman Ben Bernanke's 2002 speech on preventing deflation noted the impact of devaluation in the 1930s.


The Fed's statement this week opening the door to more easing pushed the U.S. dollar index to a six-month low. As investors believe U.S. rates will stay low, the dollar may become more favored to fund carry trades.


As in the 1930s, competitive devaluations, whether by fair means or foul, are likely to increase international tensions and risk protectionist responses. Meanwhile, they will do nothing to address the global imbalances that led to the crisis or tackle the chief problem facing the advanced economies today: lack of domestic demand in many countries.


In the short term, the euro zone has the most to lose from rising currency tensions, given the relative hawkishness of the European Central Bank. The euro already has risen 2.3% against the dollar in the last week. But a rising euro could cause further problems for Europe's periphery as well as for the German export engine at the heart of the European recovery.


Longer term, the biggest gainer is likely to be gold, already pushed to nearly $1,300 an ounce this week, the traditional refuge of those unwilling to put their faith in politicians.


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