Euro Makes New High v. Yen - And So...

Bloomberg news reported today Aug 28th 2006 that the Euro posted an all-time high vs. the Japanese Yen, ostensibly because investors believe that European rates will be heading higher, faster, than Yen rates. In a related news item, Brad Setser over at RGE Global punctured the myth floating around US policy circles (particularly conservative ones) that Europeans are not pulling their weight and need to expand their domestic demand as well as their imports. The two points are undoubtedly related, and highlight the dilemma or perhaps crisis effecting the international monetary system, and sheds light on the direction where potential finger pointing might be in order.



Setser highlighted that Euro-area demand (and imports) have been rising smartly. But sadly, from a US perspective that is, Europe's goods imports have primarily increased with Asian exporters, hence their new vigour and demand take-up has done more to increase Asian surpluses than they have done to make a dent in US deficits. Such is the luck 'o the draw in a free-market. This is partly the result of the goods and services the US has to offer, in addition to the impact of a Japanese Yen that’s de facto shadowing the RMB, an RMB that’s more explicitly pegged to the dollar, and a dollar that’s been depreciating against the Euro, and it's entire trade-weighted basket, creating a daisy chain resulting in Euro appreciation vis-à-vis the RMB and Yen, for no good reason(s), and undoubtedly some rather bad ones, since the Euro area is in rough balance, while the neo-mercantilists of the Pacific ride roughshod over the spirit of the international monetary system.

The new high of the Euro vs. Yen (as pictured above is significant, if for no other reason than it is wrong. It is wrong in regards to the spirit of the international monetary system, for it neutralizes the market mechanism of "relative price" for which the system depends to nudge the balance of payment accounts in a direction more convergent with long-term sustainability. And with nothing to police the system, the lack of market signal and pressure allows cynical free-riding, or worse, potentially lethal parasites. This in no way pejoratively judges the necessity or determination of China and its people, still a poor country, to develop rapidly. However, undermining the systemic mechanism of adjustment carries with it great cost and moral hazard - something that seems to be viewed somewhat cynically in Beijing, if actions imbue more meaning than words (which I believe they do). At the very least, everyone must recognize that continuation of the status quo, without meaningful appreciation of the RMB vs. USD and Euro runs the very real risk of seeing the world retreat down the rat-hole(s) of beggar-thy-neighborism, protectionism, or, in the extreme US repudiation or default. In the intereim, it opens the system up to the possibility of real speculative attack that would find the authorities defending the wrong side of the trench in the war. The resulting costs and economic dislocations from such systemic turmoil are immense, and one need only look at Argentina for a view of what unresolved bad policy can produce in teh realm of mayhem & chaos.

But this post was NOT primarily about China, but about the focus of Cassandra’s Love-Hate relationship: Japan. For Japan, the above picture is the Euro/Yen, and there can be no excuse. The Japanese are first-world, and one of the richest nations on earth. Their focus upon, and domination of, world markets in may key areas is without comparison, providing rents which sustain a rich quality of life and advantageous position. And this is a position that has been made possible by a world monetary order dependant upon cooperation and respect for the rules of the game. Yet the domination of markets more than sufficient to sustain them appears not to be enough to satisfy them. And so they illicitly beggar jobs from the USA and Europe by currency exchange rate manipulation using direct intervention and unparalleled reserve accumulation of dollars. Even against China, they refuse to allow the hollowing on anything but THEIR terms, hollowing that the USA and Europe have been granting de facto to the developing world for two and a half decades. This is as it must be. IF Japan insists on using whatever means necessary to trash its currency in order to gain pecuniary economic and parochial advantage for its corporations and its citizens, the Japan must be prepared to pay the ultimate price: systemic breakdown, eventual collapse or severe devaluation of the central currency (the USD); potential seizure of Japanese assets abroad. None of these things should be viewed joyfully, or wished for. But, if one is playing a game with rules, and one persistently breaks the rules, one should be prepared for the consequences, whatever they may be. For the level-headed eastern-establishment trilateral-types in the US may, in the future, be unable to prevent the more aggressive emotions erupting from the rust-belt of formerly triumphal America, intent on finding a whipping-boy and flogging him.