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Modern Currency Wars : The United States versus Japan

Author

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  • Ronald McKinnon

    (Asian Development Bank Institute (ADBI))

  • Zhao Liu

Abstract

In the currency wars of the 1920s and 1930s, various nations fell off the gold standard and in so doing experienced deep devaluations. But under the postwar dollar standard, the central position of the US was key to maintaining the peace, until the Bretton Woods system of fixed dollar exchange parities fell apart after the so-called “Nixon Shock†of 1971. Now, without much fear of retaliation, the US can initiate more limited currency warfare—as with American “Japan bashing†from the late 1970s to mid-1990s to appreciate the yen, or “China bashing†since 2002 to appreciate the renminbi. Japan succumbed to this bashing, and the yen appreciated too much in 1985, with the result that Japan fell into a zero-interest liquidity trap and economic stagnation for almost two decades. However, in 2013, through massive quantitative easing by the Bank of Japan (BOJ), the yen depreciated about 25% against the dollar, stoking fears of a return to Japan bashing by the US. However, this sharp depreciation simply restored the purchasing power parity of the yen with the dollar so it should even out in the long run. In the short run, we show that yen depreciation could adversely affect the smaller East Asian economies. Since 2008, quantitative easing by the BOJ has been similar to that carried out by the US Federal Reserve, the Bank of England, and the European Central Bank. So the BOJ can only be faulted as a currency belligerent if there is a further significant yen depreciation. Led by the US, now all mature industrial countries are addicted to near-zero interest liquidity traps in both the short and long terms. These ultra low interest rates are causing lasting damage to the countries’ financial systems, and to those of emerging markets, which naturally have higher interest rates. But exiting from the trap creates a risk of chaos in long-term bond markets and is proving surprisingly difficult.

Suggested Citation

  • Ronald McKinnon & Zhao Liu, 2013. "Modern Currency Wars : The United States versus Japan," Finance Working Papers 23714, East Asian Bureau of Economic Research.
  • Handle: RePEc:eab:financ:23714
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    References listed on IDEAS

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    1. Gabriele Galati & Alexandra Heath & Patrick McGuire, 2007. "Evidence of carry trade activity," BIS Quarterly Review, Bank for International Settlements, September.
    2. Hyun Song Shin & Masazumi Hattori, 2009. "The Broad Yen Carry Trade," World Scientific Book Chapters,in: Globalization And Systemic Risk, chapter 11, pages 169-189 World Scientific Publishing Co. Pte. Ltd..
    3. Angelo Ranaldo & Paul Söderlind, 2010. "Safe Haven Currencies," Review of Finance, European Finance Association, vol. 14(3), pages 385-407.
    4. Alan Ahearne & Naoki Shinada, 2005. "Zombie firms and economic stagnation in Japan," International Economics and Economic Policy, Springer, vol. 2(4), pages 363-381, December.
    5. Habib, Maurizio M. & Stracca, Livio, 2012. "Getting beyond carry trade: What makes a safe haven currency?," Journal of International Economics, Elsevier, vol. 87(1), pages 50-64.
    6. Ronald McKinnon & Gunther Schnabl, 2003. "Synchronised Business Cycles in East Asia and Fluctuations in the Yen/Dollar Exchange Rate," The World Economy, Wiley Blackwell, vol. 26(8), pages 1067-1088, August.
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    Cited by:

    1. Akihito Asano & Rod Tyers, 2016. "Japan's oligopolies: potential gains from third arrow reforms," CAMA Working Papers 2016-03, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    2. repec:krk:eberjl:v:2:y:2014:i:2:p:21-30 is not listed on IDEAS
    3. Akihito Asano & Rod Tyers, 2015. "Third Arrow Reforms and Japan’s Economic Performance," Economics Discussion / Working Papers 15-17, The University of Western Australia, Department of Economics.
    4. Kawai, Masahiro, 2015. "International Spillovers of Monetary Policy: US Federal Reserve's Quantitative Easing and Bank of Japan's Quantitative and Qualitative Easing," ADBI Working Papers 512, Asian Development Bank Institute.

    More about this item

    Keywords

    Currency wars; US; Japan; the Bretton Woods system; dollar standard; a zero-interest liquidity trap; ultra low interest rate;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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