The currency wars — Policy intervention cannot go against market logic

When criticised about the US administration’s
exchange-rate policy vis-à-vis the yen, former US president George H. W. Bush
apparently retorted in a fit of pique, “Let the Japanese handle their exchange
rate and we will handle ours.” Unfortunately, this bit of curious Texan logic
doesn’t quite hold in the world of currencies. One currency’s gain is
tautologically another’s loss.

The US central bank, the Federal Reserve, seems
reconciled to another round of quantitative easing (economist-speak for printing
more greenbacks) and that could lead to a further fall for the dollar. The
problem is that these cheap dollars find their way into emerging markets like
China and India (whose asset markets offer better returns), causing their
currencies to appreciate and their export competitiveness to erode. The dollar
has thus become the principal ‘carry currency’ that investors borrow in (at
virtually zero cost) and fund investments in higher-yielding assets of the
emerging markets. Europe and Japan are caught in the middle — saddled with
sluggish economies but witnessing a rapid rise in their currencies against the
dollar. Japan has tried to thwart a steady appreciation of the yen by dropping its policy interest rate close to zero and
intervening in the currency market. This hasn’t quite paid off yet.