One can argue that this battle has been going on for years (decades?), but has reached a new phase with the election of the new LDP led Japanese Administration led by Prime Minister Shinzo Abe. Abe’s comments about how Japan can no longer tolerate the U.S. and Europe devaluing their currencies against the yen tends to confirm the view that Japan is inching closer to the policy adopted by the Swiss central bank a couple of years ago in terms of drawing a line in the sand over continued yen strength.
With the depreciation in the yen there has been a sudden and loud chorus of complaint from the Eurozone that the Japanese are instigating a currency war. At Davos the French Finance Minister indicated that the high euro had become a problem. This suggests that some of the intervention positions that lifted the euro will probably be unwound in order to reduce the euro exchange rate now that the yen has fallen.
In the attempt to diversify their foreign exchange holdings, central banks have increasingly piled into the yen as a “safe haven currency”, even as that strength has destroyed Japan’s industrial competitiveness and hollowed out its manufacturing base. If they stop buying, the fall in the yen could be precipitous. The only outlet for an improvement in the Eurozone’s economic growth prospects is via its external accounts, given prevailing tight fiscal policy in most countries. So they would be very unhappy with a much stronger euro certainly relative to the yen.
And if the ECB tolerates a falling euro as the current spec long positions are unwound, then what will the Federal Reserve do? It seems like all of the major players are at the starting lines, all set to kick off a new round of competitive devaluations. On your marks, get set….