Japan leads round of competitive devaluations

Deflation.pngThe blog remains very concerned that, overall, the economic policies adopted during the current Crisis are leading the world economy to the worst possible outcome. This outcome is totally predictable. Indeed it has been predicted by reputable experts for some years. Yet most policymakers still seem intent on dealing with symptoms rather than causes.

As evidence for this argument, the above chart first featured in the blog 18 months ago. It was developed by Comstock Partners, but many others identified the same logic. And sadly, we continue to move through exactly the cycle it defines:

• Originally, China/Asia boosted savings and investment, whilst the West ran up huge debts in creating demand to utilise this investment eg in housing, autos.
• Equally, the West created huge over-capacity in services, particularly financial services, in order to recycle Asia’s savings into Western debt.
• Inevitably, the world then reached a position where this excess capacity led to growing weakness in pricing power – causing the Crisis which is now with us.

Did Western policymakers stop at this point, and ask themselves what was happening? Not as far as the blog has observed. Instead, they focused on short-term measures such as stimulus programmes to boost demand, in the mistaken belief that the problems were caused by a lack of market liquidity, rather than solvency.

The EU’s efforts to avoid debt default by Greece are just one example of this. Equally, Germany’s weakening of the new Basel bank capital rules to avoid problems for its bankrupt state banks. Or, indeed, the Obama administration’s apparent belief that their stimulus programmes would produce ‘escape velocity’, with the US consumer quickly returning to full spending mode.

Meanwhile in Asia, China has begun quietly devaluing versus the trade-weighted average of partner currencies, spending $1bn a day in the process. It has also been forcing up the value of the Japanese yen, buying $12bn of government bonds in June-July.

China’s premier, Wen Jiabao, has also ruled out any “drastic appreciation of the renminbi” against the US$. Noting that China’s factories receive only $6 for each $299 iPod sold, he warned, “you don’t know how many Chinese companies would go bankrupt. There would be major disturbances. This is the reality.”

Yet in the USA, the administration seems increasingly keen on a ‘weak dollar’ policy, to support its desire to double US exports over the next 5 years.

Now, Japan has publically signalled the move to the next stage of the Crisis, with its decision to competitively devalue, to try and maintain its exports. Its export-driven economic model simply can’t survive with the yen above ¥95: $1.

As before, this short-termism clearly cannot work long-term. With world trade no longer expanding, nobody is now able to take on the role of ‘importer-of-last-resort’ that has been adopted by the USA and Western Europe in recent years. Instead, the politicians are all mindful of the increasingly protectionist mindset of their electorates, with unemployment at high levels.

So the stage is now being set for the next phase of the Crisis, namely protectionism and tariffs. The first signs are already beginning to appear. And they will undoubtedly increase in volume next year, if the major developed economies (Europe, N America and Japan) continue to stagnate. These regions, after all, do account for two-thirds of global GDP.

In the meantime, more and more governments are planning to further reduce demand by imposing austerity programmes, in the mistaken belief that their previous policies have delivered economic recovery. The outlook therefore does not seem very optimistic, even to the blog.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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