Currency war likely soon

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Currency war likely soon

In a desperate move to halt the sharp rise in its currency and help exporters rescue the economy from a two-decade slump, Japan has intervened in the currency market by selling an unprecedented 2 trillion yen ($23.3 billion) to buy U.S. dollars. Japan’s intervention is first in more than six years.

The move followed the re-election of Prime Minister Naoto Kan and stunned the market that bet on further yen strengthening. It also sent the currency to a 15-year high against the dollar with the prime minister’s views and opposition to currency manipulation. Considering Japan’s move has been a solo dance without backing from other countries, the yen’s weakening won’t likely last long. Complaints from the United States and Europe - also battling with their own economic and trade problems - will also put a brake on the yen’s weakening trend.

The yen’s rally is a structural problem. Foreign capital is being lured to the relatively safe yen due to unpredictable economic prospects in the U.S. and Europe. Japan had been able to deal with yen’s sharp rise until recently through yen carry trade, in which investors borrow yen at near-zero yield levels and use the loans to buy higher yielding assets elsewhere, for example U.S. Treasuries. But after the Wall Street-sparked financial meltdown, many other markets offered ultra-low interest rates. The leveraging of yields has stolen the limelight from the yen for such trades. Moreover, if U.S. monetary authorities inject more liquidity and buy Treasuries to stimulate the economy, investors can reverse trade and send the yen higher due to increased demand to pay back yen loans.

What’s most worrisome is that meddling by the world’s second largest economy to keep its currency undervalued can start a war on the foreign-exchange front. It may be the end of the tight alliance among the G-20 economies to keep a hands-off currency policy. A war among monetary authorities can erupt as they support local exporters to sell their goods more cheaply in a sluggish global market. The curtain will inevitably fall on an coordinated dance to make way for solo performances.

In a currency war zone, the yen and the Chinese yuan will likely go strong for a long time. The Korean won will likely synchronize with the two. The Korean economy has weathered global economic turmoil because of growing exports benefiting from a weak currency. But the wind may not be favorable from now on. There is no magic bullet in a currency war. The best option would be not depending on prices, but raising quality and cutting costs through restructuring efforts. It is a painful process. The smoke over Tokyo is a harbinger demanding us to come up with contingency plans and actions.
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