Published in the National Post on March 23rd, 2015
By: William Robson
William Robson is president and CEO of the C.D. Howe Institute.
Scary headlines sell, and the world economy since the 2008 crisis has given writers of scary headlines lots of material. Lately, the large type has featured two themes: Deflation, which threatens to suck the major economies into a black hole; and currency wars, which will have us at each other’s throats as we sink.
Hoping a turn of phrase can compete with the prophets of disaster, I must protest: this is altogether too much of a bad thing. The deflation doomsayers and the currency-war Jeremiahs can’t both be right. Yes, deflation is a threat — in theory. But probably not in reality. And if a desire to devalue their currencies prompts central banks to print more money, certainly not in reality.
That assurance may seem glib to the deflationists. They can certainly point to some anemic price measures. In the United States, the consumer price index (CPI) is down year-over-year, as are consumer prices in the Eurozone.
Last month, Bank of England Governor Mark Carney had to write a formal letter to the Chancellor of the Exchequer explaining why U.K. inflation is more than 1 percentage point below target. Even here in Canada, where demand has been relatively robust since the crisis, CPI inflation is right at the bottom of the Bank of Canada’s 1%-to-3% band.
Moreover, the doomsayers point out, these numbers don’t yet show the full impact of lower oil prices since last summer. A recent “leader” (editorial) in The Economist warned that people may come to expect continuously falling prices. They might start stuffing cash into mattresses. Central banks won’t be able to expand money and credit. Spending and output will grind to a halt — as happened in the 1930s.
The prophets of currency wars can also cite startling statistics. Most exchange rates are quotes against the U.S. dollar, and against the U.S. dollar, most currencies are way down. The Euro recently hit a 12-year low. The U.K. pound is down more than 10% over the past year. Emerging-market currencies have tanked. Even the Canadian dollar, almost 94 U.S. cents last summer, is close to 78 cents now.
For U.S. exporters, these swings are a problem, as they are for anyone outside the United States with big U.S.-dollar debts. But the concern is broader than that. We’re hearing talk about currency manipulation, competitive devaluations, beggar-thy-neighbour policies … more ominous references to the 1930s.
Enough already! The headlines in the 1930s were truly disastrous. On the economic front, country after country closed its borders to goods, capital and people. Central banks, preoccupied with the gold standard and balance-of-payments considerations, let the money supply shrink. Economic nationalism and misery helped bring about the most destructive war — actual war, not some headline-writer’s metaphor — in history.
Happily, the post-2008 period has been profoundly different. We have seen much less protectionism. Many countries, Canada among them, are actually liberalizing. While growth has been slower than hoped, living standards for most people in the world are still rising. A key reason for the lower price of oil is expanding supply, and more abundant energy is a good thing. We’re still trading with, not shooting at, each other.
As for currency wars, they don’t mean live winners and dead losers. A country that wants a lower exchange rate just has to create more of its own currency, increasing supply relative to demand so that its price in foreign currencies falls. If it goes too far, and an over-rapid increase in the supply of currency pushes its domestic value down, then the losers are its own citizens, who suffer from inflation.
Yes, inflation — which is why fears about deflation and currency wars are too much of a bad thing. They can’t both be right. Much of the talk about competitive devaluations comes from the United States, and no wonder. The U.S. dollar is on a tear — up against everybody else — so from the U.S. perspective, everybody else looks low.
So suppose the U.S. Federal Reserve reacts to the currency’s strength with monetary policy that is easier than it would have been otherwise. That will make U.S. inflation likelier to get back to the 2% range the Fed wants. And if, say, the European Central Bank doesn’t like the Euro’s resulting rise against the U.S. dollar? It will ease as well — which will make prices in the Eurozone likelier to start rising.
At this point, the relentlessly dire headline writer might turn to Japan. Doesn’t two decades of Japanese stagnation prove that you can’t fight deflation with the printing press? Not at all: after years of holding back, the Bank of Japan has become more aggressive. The Yen is weaker, down almost 20% against the U.S. dollar in the past year. And during that time, Japanese consumer prices are up 2.4% – an increase bigger than changes in sales taxes can explain. No deflation there.
Not everything is rosy in the world economy. But dire headlines about deflation and currency wars together are, simply, too bad to be true. Doomsayers should pick their disaster. For the rest of us, maybe there’s no disaster at all.
