Battle4Liberty

The Bank of Japan followed the US Federal Reserve and other central banks, unveiling its own package of easy-money policies on Thursday. By doubling its holdings of government bonds and the amount of yen circulating in the economy, the Bank of Japan is essentially printing money to create inflation and drive down the value of the yen relative to other global currencies. The value of the yen has already declined substantially since November 2012 in anticipation of such a move. A US dollar buys 97 yen today compared to about 80 5 months ago, resulting in a yen-to-dollar depreciation of over 20%.

The Keynesian thinking is that a weak currency boosts an economy by making exports cheaper and raising the price of imports, thereby encouraging citizens to buy goods produced domestically. A central bank’s easy-money intervention accomplishes this goal, thereby devaluing the currency and creating inflation. These facts are not disputed. As noted in a recent Fed letter, “Surprise unconventional policy easing has pushed down the value of the dollar roughly as much as similar surprise downward moves in the federal funds rate did before the crisis” (see www.efxnews.com/story/18074/sf-fed-paper-dollar-has-been-victim-fed-unconventional-monetary-policy).

The arguments of Paul Krugman and other Keynesians notwithstanding, a devalued currency doesn’t help a nation in the long run. The inflation it causes is an indirect tax on wealth and devaluation expectations scare potential investors. But what happens if all developed nations seek to devalue their own currencies? The result would be a currency war. This is a serious possibility, as Japan is simply joining a lost list of nations–including the US–that have already gone down this road.

The answer is not very complicated. If every nation devalues its own currency, then no nation will obtain any short run relative trade advantage because the devaluations cancel each other out. Such a combination of independent central bank actions would have the same effect as a coordinated global currency devaluation. Some economists and politicians might actually like to see this, as it would decrease the value of government debt at the expense of inflation and current cash holdings, including those at corporations and in retirement accounts. Any currency devaluation steals from those who hold wealth by reducing the purchasing power of their cash holdings.

Japan’s move will encourage other central banks to follow suit, and an impending global currency devaluation would have a devastating effect on the US economy. Interest rates would rise because investors will demand higher returns on government debt. At current debt levels, a 3% hike in the interest rate would increase our annual interest payments by about $500 billion. Faced with rising inflation, the Fed would be forced to raise interest rates, which have been kept at artificially low levels to prime the economy and prop up the housing market. While the full effects of these currency devaluations will not be felt immediately, they–like most Keynesian policies–will kill us in the long run.