Spring 2013

CURRENCIES: Abenomics for beginners

Toy-soldiersHeadline writers sometimes need to resist the temptation to use inflammatory phrases as they try to attract readers, finds Stefanie Eschenbacher. But why lead with currency wars when there is something as arresting as Abenomics? Wikipedia saw a new entry in February: Abenomics. “A portmanteau of Abe and economics, the term refers to the economic policies advocated by the prime minister of Japan, Shinzo Abe.” The online encyclopedia offers a short explanation of what these politics entail – an inflation target of 2%, expansion of public spending, “correction of the excessive yen appreciation” and “radical quantitative easing”. The next subheading in Abe’s Wikipedia entry is criticism. And it is likely this is going to expand substantially. Abe plans to spend more and boost the ailing Japanese economy through massive stimulus, an attempt to end nearly two decades of stagnation. Japan’s aggressive monetary expansion has already weakened the yen substantially. Since the end of October, the currency has lost more than 20% in value. Tensions in Asia have grown markedly. The rapid depreciation of the Japanese yen has heightened concerns among Asian rivals that Japan will get a competitive advantage in key export markets, such as electronics and automobiles. Mouhammed Choukeir, chief investment officer at the private bank Kleinwort Benson, says the recent efforts to stimulate Japan’s economy have caused a stir in the $4 trillion a day foreign exchange markets. As the global economy scrambles for every basis point of growth, Choukeir says currencies can be a powerful way to achieve a competitive advantage. In fact, he calls them “weapons of mass devaluations”. Devaluations make domestic goods cheaper and tilt consumption preferences to local producers, which increases domestic output and lowers unemployment; this, Choukeir adds, “makes a re-election speech much easier”. And, inevitably, when discussing both currencies and current affairs, the word currency war does slip in at some point. CURRENCY WAR
The latest person to make headlines worldwide with currency wars was Yi Gang, the deputy governor of the People’s Bank of China, the country’s central bank. “China is fully prepared,” Yi told Xinhua, the country’s official press agency. “In terms of both monetary policies and other mechanism arrangement, China will take into full account the quantitative easing policies implemented by central banks of foreign countries.” Currencies tableThe term currency war was coined by Brazil’s finance minister Guido Mantega, who used it more than two years ago to refer to competitive devaluation of currencies. When G20 finance ministers met in Moscow in February, currency wars again featured high on their agenda. Jan Randolph, director of sovereign risk analysis at IHS Global Insight, says emerging markets in the G20 (Brazil, India, Turkey and Russia) do accuse the West (the US, Europe and Japan), of deliberately weakening their own currencies. He says Abe gave a “second and added impetus” when he called for the central bank to engage in much more aggressive monetary expansion. However, Randolph adds that the world economy is not yet in the danger zone of the competitive devaluations of the 1930s. Those policies eventually led to a collapse in world trade and output, along with mass unemployment that made the Great Depression far worse. John Greenwood, chief economist at Invesco, says the term is “inappropriate and inaccurate”. He adds: “What the world is really trying to avoid is not a currency war, but trade restrictions, such as tariffs and quotas. Unlike the 1930s, few of these policies have been imposed since 2008.” Peter O’Flanagan, head of foreign exchange dealing at Clear Currency, says any talk of currency wars makes a good story and a bold headline. “In reality, what we see in the market these days is not outside the normal operation of central banks over the last 20 years, we are just seeing it on a much larger scale,” he says. “In recent years, with slowing global growth and central banks running out of solutions to combat this, a currency devaluation is the last weapon left in the arsenal to try and spur some growth.” The idea of currency devaluation or debasement is false because currencies traded against each other and, as one appreciates another depreciates. Currencies are rarely devalued to nothing (on purpose). “It is true that the strength of a currency has moved away from traditional valuation methods with fundamental and future values now taking second place to expected central bank intervention or easing policy,” says O’Flanagan. Greenwood says individual countries were concentrating on domestic policies and the currency depreciations were simply “a side effect”. He says: “Currency war is an inappropriate, overblown and exaggerated description of what has happene,” and he adds that a recovering Japanese economy with a weaker yen will, ultimately, be better for the global economy than an ailing economy with a strong currency. Geoffrey Lunt, investment director, Asian currencies, at HSBC Global Asset Management, says the term is “inflammatory”. He adds: “Competitive devaluation or management of currencies is something we have seen in many different jurisdictions over the course of the financial crisis. “The Bank of Japan has over many years been pursuing unconventional measures to increase liquidity, so it is not surprising that Japan has declared that they would want to have a weaker yen.” Lunt says for the “northern Asian economic superpowers” – China, Japan and Korea – this means Japan is becoming more competitive. “One could argue that the yen has been too strong for too long,” he says. “It is something we have always kept a close eye on, but nothing that has the potential to derail the global economy in the sense that other developments have.” Should the yen weaken further, Choukeir warns that Japan’s trade partners are likely to fight back with their own rhetoric and quantitative easing. Industry experts do not deny that there are some concerns over weakening currencies in Asia, though. The reniminbi has weakened a little compared with the dollar, partly a result of the yen’s weakness. The Malaysian ringgit, the South Korean won and the Indian rupee have all lost value, but this is thought to be down to other factors. Malaysia is preparing for the upcoming general election; large investors rebalanced their asset allocation in South Korea, where geopolitical risk has increased; India announced reforms in February’s budget.    SILENCE
Thanos Papasavvas, fixed income and currency strategist at Investec Asset Management, says more interesting than the depreciation of the yen is what will happen to other Asian currencies. He says the exchange rate between the Japanese yen and the South Korean won, for example, has always been an important one. Investec Asset Management has recently taken profits on the South Korean won. “We are looking to buy the Korean currency but we want to see if it stabilises or falls further.” He says policymakers will have to decide if they raise interest rates to contain inflation or to allow their currency to strengthen. “We have seen Brazil allowing its currency to strengthen because inflation is showing signs of picking up. The last thing they want is to raise interest rates.” Papasavvas says Mantega himself has been “silent” on the Brazilian real appreciation. “Currency war is a great term for journalists and researchers, who want to write gripping headlines. But Mantega now allows currency appreciation to control inflation.” He says it is unlikely that emerging market policymakers really want weaker currencies. “It would make their exports cheaper, but it would force central banks to raise interest rates to control inflation. Domestic demand has to pick up in these countries, but this will not happen with high interest rates.” WAR AND PEACE
Both bond and equity investors typically follow currency movements closely because they affect the attractiveness of multi-currency portfolio. Alessandro Ghidini, manager of the JB Emerging Markets Inflation Linked Bond Fund, says Swiss & Global Asset Management aims to identify those currencies of countries with high leverage and diminishing potential growth – and where policy makers decided to implement very aggressive monetary actions in order to boost growth and deflate the debt. Choukeir says he considers the yen as undervalued and over sold. While being long yen is a contrarian view, he says there is empirical evidence shows that being contrarian serves the disciplined investor over time. “Such an approach requires patience. This is especially important in times of war.” Drawing from the 1869 classic, War and Peace, by Leo Tolstoy, he adds: “The strongest of all warriors are these two – time and patience.” Andrew Seaman, fund manager and partner at Stratton Street Capital, says a currency war would be a “disaster” for the world economy. “Debtors would see their currencies go down and creditors up,” he says. “They need to see their currencies go up and their current account deficit decline, and the other way round.” In some domestic bond markets, currency movements do not make much of a difference. India, for instance, is a domestic market, largely held by local banks and pension funds. In a global portfolio, the effect of appreciating or depreciating currencies will depend on whether the exposure is hedged. “Generally, in emerging markets a weakening currency is bad for most assets,” says Lunt. “But when a currency falls in value, it can be an opportunity, depending on whether it is
a secular decline or a short-term decline.” Choukeir doubts the Bank of Japan will be able to achieve 2% inflation, given its failures to achieve 1% in the years before. He says, Abe, who was prime minister in 2006 for one year, may not be in office long enough to solve Japan’s economic woes. The average tenure for a Japanese prime minister is 1.2 years. LONELY VOICE
David Marsh, chairman of the Official Monetary and Financial Institutions Forum, says the risk that world finance ministers would reprimand the new Japanese government is low. ­“Given the pumping up of central bank balance sheets in the US and Europe, any campaign to castigate the Japanese for over-enthusiastic monetary loosening would have been more than a tad hypocritical.” Currencies chart If a currency war does break out, Marsh says it is most likely between two countries that have officially abolished the exchange rate between each other: France and Germany.
Both countries have taken an uncompromising stance on the future of the monetary bloc’s currency, and Marsh says the Bundesbank has been “a lonely voice on the European stage” in the past two years. “But now, just as other central banks such as the Bank of Japan are starting to lose their autonomy, the Bundesbank may be coming back into vogue.”   ©2013 funds global asia

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