Regular readers know that a currency war is the direct result of the policymakers ongoing choice to adopt and pursue the Japanese Model for handling a bank solvency crisis. Under this model, bank book capital levels and banker bonuses are protected at all costs.
The result of the Japanese Model is to put the burden of the excess debt in the financial system on to the real economy. This causes the real economy to stagnate and/or shrink as capital that is needed for growth and reinvestment is diverted to debt service payments.
Policymakers try to offset this stagnation and/or shrinkage by engaging in stimulative fiscal and monetary policies. One of the goals of these policies is to increase exports.
Unfortunately, since we had a global financial crisis, every country is looking to increase exports. When everyone is looking to increase exports, the condition is set for a currency war because no country wants to let another country gain a competitive advantage in exports by devaluing their currency relative to that country's.
Regular readers also know that there is an alternative to pursuing the Japanese Model and its destructive consequences like currency wars. The alternative is to pursue the Swedish Model and make banks recognize upfront the losses on the excess public and private debt in the financial system.
With the banks recognizing the losses, the burden of servicing the excess debt is lifted from the real economy. Capital is no longer diverted to debt service but can be used for growth and reinvestment. As a result, the real economy resumes growing again.
With the real economy growing, there is no need for the aggressive monetary policies that result in a currency war.
Loading central banks with more tasks and pressing them to pursue more aggressive monetary policies could risk a round of competitive devaluations, European Central Bank policymaker Jens Weidmann said on Monday, citing pressure on the Bank of Japan.
Weidmann is the latest in a string of policymakers worldwide to warn of the threat of a "currency war" as central banks pump out cash to support their economies, reducing their value in the process.
He said the pressure that Japan's new government has put on the BOJ to deliver bolder monetary easing endangered the central bank's independence, as did the actions of Hungary's government.
"Already alarming violations can be observed, for example in Hungary or Japan, where the new government is interfering massively in the business of the central bank with pressure for a more aggressive monetary policy and threatening an end to central bank autonomy."
"A consequence, whether intentional or unintentional, could moreover be an increased politicisation of exchange rates," the Bundesbank chief, who also sits on the ECB's Governing Council, said in a speech at a Deutsche Boerse New Year's event.
"So far the international currency system has come through the crisis without a devaluation competition, and I hope very much that remains the case," Weidmann added in a section of his speech entitled "independence of central banks in danger"....After 2+ decades of a stagnant real economy following its adoption of the Japanese Model, Japan is desperate to resume growth. Hence, it is moving towards pre-emptively engaging in a currency war with the rest of the global economies.
"But the overburdening of central banks with tasks and expectations is definitely not the right way to overcome the crisis in a sustainable way," he added. "Central banks protect their independence best by interpreting their task narrowly."
"The key to handling the crisis does not lie with the central banks."...Indeed, the key lies with policymakers adopting the Swedish Model and putting the real economy and the taxpayers ahead of the bankers.
Weidmann struck a bleak note on the prospects of both the euro zone and the United States overcoming their debt problems, saying there was no quick, simple way to fix them.
"The adjustment process to bring state finances and economic structures back into order is not a matter of months or a few years," he said.Actually, as demonstrated by Iceland in the current financial crisis, it is a matter of months to bring state finances and economic structures back into order if the Swedish Model is pursued.
If a country pursues the Japanese Model the adjustment process never occurs. Just look at Japan which has never recovered from its bank led solvency crisis in 2+ decades.