Capital Markets: Will Abenomics Cause a Currency War?

January 31, 2013

 Post-Davos chatter reflects finance ministers’ concerns about competitive devaluations.

Japanese Prime Minister Shinzo Abe has rattled his Asian neighbors with his ongoing efforts to kick-start the country’s economy. His pressure on the Bank of Japan caused it to double its inflation target to 2 percent last week, commit to hitting that target as fast as possible, and institute an open-ended asset buying program. Dubbed “Abenomics” in the press, the moves prompted criticism from the central banks of China, South Korea and Taiwan at the Davos meeting last weekend.

Taiwan’s central bank announced on Monday that it would intervene in the FX market if Helicopter Abe’s liquidity dump caused a sharp devaluation of the yen. South Korea’s central bank followed suit, as did Thailand. Reuters quoted Yi Gang, deputy governor of the Peoples Bank of China and the country’s top FX regulator, as saying, “Quantitative easing for developed economies is generating some uncertainties in financial markets in terms of capital flows. Competitive devaluation is one aspect of it. If everyone is doing super QE, which currency will depreciate?”

At Davos, the Japanese move alarmed Korea’s central bank officials, who said that Japan had acted hastily and could cause significant FX volatility. Others chimed in with worries that a unilateral devaluation could spur a currency war or at the least, some increase in protectionist sentiment in Asia.

The chance that this situation could spin out of control is remote – after all, there is an enormous amount at stake. Nonetheless, until it is settled, treasurers will be forced to keep a close eye on the day to day developments in the region in order to tweak their FX forecasts and to decide whether to hedge against fat-tailed events.

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