Usterilized Foreign Exchange Interventions Might Be The Last Best Hope for Growth

(cc photo by MShades)

(cc photo by MShades)

Japan announced a currency intervention today aimed at making the Yen weaker and bolstering the country’s export sector. Such interventions rarely actually succeed in changing currency prices since foreign exchange markets are so big. But as Felix Salmon explains, the Japanese are doing something a bit unusual in that their sales of Yen will be “unsterilized.” What does that mean?

In other words, the Bank of Japan isn’t simply selling yen, it’s printing yen. (And then selling them.) Given (a) that it’s the central bank and that it can print as many yen as it likes, and (b) that it would actually welcome a bit of inflation, there’s actually a non-negligible chance that this kind of non-sterilized intervention could work.

The Economist’s Buttonwood has an oddly pessimistic take on this:

My thought concerns the general tendency of countries to want their currencies to depreciate. Everyone would like to boost their growth by letting their currencies slide and increasing exports. Of course, not all can succeed. Someone must increase net imports and let their currency appreciate. The obvious candidate is the Chinese, but they are unwilling to let it happen (at least at a pace desired by the rest of the world).

The result is like a game of deflationary pass the parcel in which the countries with appreciating currencies eventually feel the pressure, and try to reverse the trend.

I don’t worry about this at all. I asked once what people thought would happen if the Fed, ECB, and BOJ all attempted a circular devaluation in which each central bank does a foreign exchange intervention. This Japan story gives us the answer. If central banks attempt a circular devaluation with sterilized interventions then, as Buttonwood says, nothing will happen. But if they all follow Japan’s example and enact unsterilized foreign exchange interventions, then the upshot will be a larger money supply and a higher price level. As Ryan Avent observes, almost all the developed economies could use some more inflation (and the main exceptions I can think of, the UK, wouldn’t be impacted by this) so this would be a good thing.

Wouldn’t it be simpler and cleaner for central banks to simply undertake monetary stimulus on their own? It would. But central bankers seem unwilling to do this. Buttonwood’s hypothesis is that Japan’s aggressive actions may force the hand of the Fed and the ECB. If it happens, that would be excellent news.