Regular readers know that this 'policy' is the direct result of adopting the Japanese Model for handling a bank solvency led financial crisis and protecting bank book capital levels and banker bonuses at all costs. If we weren't protecting bank book capital levels, the banks could recognize the losses on the excess debt in the economy and as a result, there would be no need to look for higher growth in exports than currently exists.
However, since we adopted the Japanese Model, the search for growth in exports is on.
One of the ways to grow exports is by engaging in monetary policies like zero interest rates and quantitative easing that devalue the currency. If the other countries don't respond, the devaluation serves to make goods manufactured in the country with the devalued currency cheaper to buyers in the other countries. The price drop encourages these buyers to consume more from the country with the devalued currency.
At the same time, the devaluation also makes goods manufactured in other countries more expensive to buyers in the country with the devalued currency. The price increase encourages buyers to either buy from local manufacturers or to cut back on consumption.
The hope of currency devaluation is that the increase in both foreign and domestic demand spurs economic growth.
Sounds great, what could possibly go wrong?
The other countries respond. After all, the economic growth experienced by the country that devalues its currency comes at the expense of the countries that don't devalue.
Currency wars occur when two or more countries engage in devaluation to protect their economies.
Unfortunately, not only do the conditions exist for a currency war, but we have at least 4 major economic areas already engaged in a currency war through pursuit of monetary policies that devalue their currency.
The 4 areas are Asia, the EU including the UK, Japan and the US. Each has suffered a financial crisis and each has concluded that it is in its best interest to engage in a currency war.
Of course, when every country is engaged in a currency war, no country gains an economic advantage. Yet another limitation to monetary policies like zero interest rates and quantitative easing and an example of why pursuing the Japanese Model will always fail.
The Wall Street Journal carried an article on Japan's latest efforts to insure that its central bank not only responds to the attempt by other countries to devalue their currency, but to try to be proactive in devaluing the yen faster than other countries can respond.
Japan's incoming prime minister fired a volley into increasingly tense global currency markets, saying the country must defend itself against attempts by other governments to devalue their currencies by ensuring the yen weakens as well.
Shinzo Abe's call comes as others including Bank of England Gov. Mervyn King warn that the world's economic-policy makers risk becoming embroiled in currency spats that could heighten tensions among countries.
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