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Wednesday, May 14, 2003

Currencies and Deflation: The Debate Continues

If things continue like this, my guess is that both the intenational currency markets, and the international equity markets are going to get extremely nervous. Having a rising euro which pushes Germany (and Italy!!) into deflation just doesn't make sense as a long term strategy. Nor is a rising yen going to help an already deflation-bound Japan. The US won the war in Iraq, and now has the 'clout' to impose its will. But what purpose does it serve saving the US scalp by sinking the rest. Contrary to what some say, there is no 'foolproof path' available here. Where does the money go? This is the problem, and this in its way could be the 'shock' that Stephen Roach most fears, the realisation that there may be nowhere to hide, no safe-haven left. After all it can't all go to China. If my memory serves me right, it was in the fear economy that Krugman argued that the biggest problem of all was not the deflation itself, but the shift in expectations towards a horizon of self-perpetuating deflation. One anecdotal detail, visits to my deflation blog have grown by a multiple of ten over the last week, my feeling is that our expectations may be shifting, right now as I am writing this. Whoever 'Mr Yen' is, he's not entirely on the wrong path, deflation is not a monetary phenomenon, it all depends, however, on what you mean by 'structural'.

International tension over exchange rates, accompanied by news of a widening US trade deficit, compounded the uncertainty in currency markets on Tuesday. John Snow, US Treasury secretary, warned that actively managing currencies was no route to prosperity and that Europe and Japan should not blame the falling dollar for their economic troubles. The dollar fluctuated heavily in the wake of his comments, ending New York trading higher despite the release of figures showing the monthly US trade deficit widening sharply in March to its second highest recorded level. In an interview with Reuters conducted last week but released on Tuesday, Mr Snow said: "As I have said on various occasions, devaluation strategies are not well calculated to breed long-run domestic prosperity." Although his comments largely reflected US policy, they came at a time when Japanese and some European policymakers have been signalling rising concern about the fall in the dollar.

Mr Snow's comments came as the US Commerce Department said the monthly deficit in goods and services rose by 7.7 per cent in March, the biggest increase this year, to $43.46bn, well above most economists' expectations. The figures could mean that US economic growth was even slower than reported in the first quarter. Much of the import surge reflected the oil price rise that preceded the war in Iraq and the dollar's fall over the past year. But a sharp increase in oil volume also played a significant role, and the rise in imports was broad-based. Eisuke Sakakibara, the former Japanese vice-finance minister known as "Mr Yen", warned yesterday that attempts at competitive devaluation by any of the three large currency areas could be dangerous. Mr Sakakibara, now a professor at Keio University, said Japan was the forerunner in a global shift from an era of structural inflation to one of structural deflation. "Even if we do not yet have [global] deflation, you have to concede that we have disinflation," he said, attributing falling prices to rapid productivity gains in manufacturing, particularly in China. "Deflation is a structural, not a monetary phenomenon."
Source: Financial Times

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