The Myth of Currency Wars

One of the most pernicious myths of the current era is the idea of “currency wars.” The idea of currency wars is that one country can boost growth by devaluing its currency to boost net exports, but doing so risks embroiling the world in a zero-sum war of competitive devaluations.

This makes very little theoretical sense. For deliberate devaluation to be sustained, the devaluing country needs to raise its inflation target (because imported goods are getting more expensive). And while raising your inflation target may or may not be a good idea, it’s certainly not a zero-sum idea. Above, you can find a little empirical demonstration of this. The takeoff in Japan’s Nikkei index since Shinzo Abe started making noise about higher inflation is striking, but the FTSE and the S&P 500 have been moving up since around that time too. Not coincidentally, Mark Carney in the UK and Ben Bernanke in the US have also been making expansionary noises for the past several months. That’s exactly why you’ve seen the hand-wringing about currency wars. But the equity markets provide no hint of that zero-sum dynamic. The boats are all lifting together.

What the world needs is for the European Central Bank to join the party, and for everyone else to get a little more forceful and clear about what exactly they’re trying to do.