Post From KTFA by Pragmatist » May 7th, 2014,
The Rich World's Currency Problem
MAY 7, 2014 9:21 AM EDT
Policy makers in some of the world's largest economies are facing a difficult challenge: Exchange-rate movements are starting to undermine their efforts to achieve a robust and lasting recovery.
Exchange rates can help and hinder countries' efforts to make their economies more competitive and to address trade and financial imbalances. They act primarily by changing the price of "tradable" goods and services that can be sold across borders -- such as automobiles or software development -- relative to those that can be produced and consumed only at home, such as haircuts.
Ideally, they support comprehensive policies aimed at promoting high-quality economic growth, stable inflation and overall financial calm. More often, they create lots of short-term noise, but don't do too much harm.
Sometimes, though, exchange rates can distort the efficient allocation of resources and thus undermine national and global economic development -- particularly when the policies of central banks and governments are out of sync, or where countries in different circumstances are part of rigid currency zones such as the euro area.
At the extreme, misbehaving currencies can drive economic chaos and hyperinflation. The global impact of currency misalignments is particularly consequential when they involve the dollar, euro and yen, because each serves as a medium for economic and financial interactions extending far beyond the issuers' borders.
Lately, the movements of these "G-3 currencies" have been gradually evolving from a source of noise to a more important headwind to economic recovery. The euro rose this week to a seven-week high of 1.39 dollars, up from 1.35 just three months ago (which itself was deemed too appreciated for the region’s economic situation).
The yen strengthened to 101.7 per dollar, compared with 105.3 at the beginning of 2014 -- again running counter to what the economy needed.
In the process, the dollar's value against a basket of currencies fell to its lowest level since October, even though it should be benefiting from a “flight to quality” amid jitters about the worsening situation in Ukraine.
The primary drivers are short-term and financial. Lower yields have made the U.S. less attractive as a destination for overseas capital, a phenomenon particularly relevant for Japan.
Meanwhile, brightening European prospects are attracting capital inflows. Witness the records set by yields on Italian and Spanish 10-year government bonds, which both fell below 3 percent recently.
While rational and explainable, the G-3 exchange rates are not conducive to a well-balanced global recovery. By making European and Japanese exports more expensive abroad and by reducing the relative prices of imports, they have a damping effect on growth and inflation in two parts of the world that need more of both.
They also undermine what are already incomplete policy efforts in countries such as Spain and Greece, which are trying to revive underperforming economies by making their goods and services more globally competitive.
The good news is that governments have the power to fix the problem, by iterating to a better economic policy mix, by advancing with productivity-enhancing structural reforms, and by better coordinating policies internationally.