Monetary War: The Latest Version of Protectionism

Published February 15, 2013

French president Francois Hollande’s statement that the euro should not fluctuate according to the mood of the market; the complaint by Eurogroup president Jean-Claude Juncker about the euro being “dangerously high”; and the Bank of Japan’s recent decision to weaken the yen with “aggressive” quantitative easing confirm what we already knew: The world is at monetary war.

Officials at Russia’s central bank recently called it exactly that, and Brazil’s government has been warning about it for quite a while. Speaking for a host of emerging countries in an op-ed piece in the Financial Times, Chile’s finance minister cried out against the devaluation of the currencies in rich countries. But it may be too late—emerging countries themselves are buying U.S. dollars frantically in order to prop up the greenback and push down their own currencies.

Open Protectionist Confrontation’

What does it all mean? Essentially that, just as in the 1930s during the Great Depression, everybody is in open protectionist confrontation against everybody else. Back then the “beggar-thy-neighbor” policies started with the Smoot-Hawley Tariff Act of 1930. This time responsibility for triggering the devaluation race in the developed world is more widespread but the objective is similar to that of tariff policy in the 1930s.

The headlines in the wake of the bursting of the bubble in 2008 seemed to indicate the world had learned the lesson of protectionism. Every important leader said their country would not seek an end to the crisis by using artificial methods to gain competitiveness. But this is exactly what they did. Although in several cases they raised tariffs directly or indirectly, the preferred way was to debase the currency through inflationary expansion.

One way to measure the impact, for instance in the case of the U.S. dollar, is to track the price of gold—which has doubled since 2008.

The United States was not the only culprit. Many others joined the party. But until now these “beggar-thy-neighbor” policies had not translated into open political bickering among allies. This has recently changed, probably because of the dramatic start to Shinzo Abe’s government in Japan. He has pressured the Bank of Japan to inflate the yen (its value dropped in a matter of days), while announcing, at the same time, a ¥10.3 trillion fiscal stimulus.

Another factor in bringing the fight into the open may be that the effects of money creation are now being felt more acutely around the world. To judge by the voices calling for a weaker euro, this will continue.

‘Masochistic Way to Become Competitive’

Devaluation is a masochistic way to try to become competitive since it consists of hurting oneself. In theory, by devaluing the currency you export more and become richer. In reality, you import less because imports become more expensive. In order to purchase what you used to buy before debasing your currency, you now need to export more (the purpose of exports is to pay for imports, not the other way around.) In any case, the “prosperity” is short-lived because eventually domestic prices go up and so does poverty.

A few heroes are keeping a cool head amid all the insanity. Let us hope they can resist the pressure. Among them is Jens Weidmann, the top guy at Germany’s Bundesbank, who has sternly warned against the monetary escalation.

Other sensible voices, in true poetic justice, are coming out of the emerging world, which is now in a position to lecture those by whom it used to be lectured. But it won’t be enough. These monetary policies tend to be an easy sell with the public, and by all indications they are already popular. This could easily be another chapter in Charles Mackay’s “Extraordinary Popular Delusions and the Madness of Crowds.”

Alvaro Vargas Llosa ([email protected]) is senior fellow for the Center on Global Prosperity at The Independent Institute. Reprinted with permission of the Institute’s The Beacon blog.