How the Falling Yen Can Save the Euro
Japan’s new bond-buying program amounts to a declaration of currency war against its trading partners, no matter how you sugarcoat it. Yet it may also prove constructive for the euro area, jolting Germany to at last adopt more growth-friendly policies. How else is Europe to overcome the deflationary sting of a depreciated yen, if not with a growth boost from the German government?
The Japanese currency fell by more than 20 percent against the euro in the past four months. Japan accounts for between 3 percent and 4 percent of Europe’s trade, but that understates the impact a weak yen has. Exports make up about 50 percent of gross domestic product in Germany, the euro area’s dominant economy. German carmakers and heavy machinery giants go head to head with their Japanese equivalents around the world, and they will have to cut prices to compete.
The European Central Bank can’t be expected to let the German government off the hook by adopting its own round of quantitative easing in response to this deflationary threat. The ECB’s immensely successful bond-buying program was one thing, quantitative easing by purchasing sovereign bonds is another. It isn’t anywhere on the bank’s agenda.
The timing of Japan’s drastic policy change is bad for Europe, and shows it isn’t a good partner. Major new German policy initiatives have been put on hold until after the country’s parliamentary elections in September. This means it will be at least five months before Germany can respond; Europe will have to muddle through until then. Japan would have been a much better partner had it waited with its shock-and-awe until September.
Still, Japan’s quantitative easing may turn out to be the straw that breaks the back of German resistance to expanding its fiscal deficit, with the aim of rebalancing its economy to favor consumer demand over exports. In the face of a soaring euro-yen exchange rate that restricts German exports, the government in Berlin might conclude that fiscal stimulus is just the right medicine to restore growth.
Japan’s policies will also create pressure for Germany to loosen its purse strings for other euro-area countries. Germany needs to spend more on euro-area structural reforms, the key for periphery partners to become cost competitive on global markets. Trading bailout money for structural reform makes sense for Germany. And it doesn’t mean going soft -- Germany can always cut off the funds if the periphery countries stop reforms.
Logically, once the elections are over, Japan’s move should also goad Germany to action in creating a banking union, which is necessary if Europe’s banks are to be put on a firmer footing. Stronger banks would help offset the deflationary effects of a weaker yen.
Critics are trying to sort out whether Japan’s new policy is a beggar-thy-neighbor move or something constructive to aid a global economic recovery. At the International Monetary Fund meetings this week in Washington, Japan’s partners looked as if they’ll soft-pedal the issue in public, while the IMF described the large scale quantitative easing as “appropriate.”
Certainly, the U.S., the IMF and Europe have been trying to get Japan to do something like this for years. But Japan’s timing creates suspicions about its motives. Had Bank of Japan Governor Haruhiko Kuroda waited just six months, such a huge injection of quantitative easing would look like a good partner doing something constructive. Instead, it seems a ploy to gain advantage -- even if it usefully pushes Germany in the direction of more growth-friendly policies.
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