Currency Market’s Dire Warning to Global Monetary Policy Making

Mr. Fu Peng is a veteran global macro investor. Previously, he worked as the Chief Macro Adviser for China Galaxy Futures and a portfolio manager at an event-driven fund based in London. He is currently a money manager on his own and also manages a media platform in China. This article was first published in Chinese on his wechat platform and was translated and slightly edited by the Cnspoon editorial team. 

Since the 2008 GFC, global governments have resorted to  “Keynesian” demand management under the backdrop of a weak economic recovery. Main economies led by the United States have initiated successive rounds of expansionary monetary policy such as QE to support growth. However, such policies mainly addressed the short-term imbalances of the economy and emphasized on the external”injection” of new demand. It has done little to address the long-term structural imbalances of the global economy. In fact, virtually all G20 members have realized that monetary policy is only a short-term resort but never a long-term cure. Structural reforms were in dire needs by all countries to rebuild healthy economic structures and address global imbalances.

Though everyone knows the real antidote is to implement structure reforms, leaders of US, EU, Japan and China had little motivation in the past to address the structural challenges – an ongoing liquidity injection rally has been witnessed and the negative repercussion of such monetary policy has transmitted from interest rates to asset markets. Excessive monetary supply has led to new imbalances – skyrocketing property prices, rich valuation in stocks and currency depreciation have led to a more prevalent systemic risks, i.e. global asset bubble and beggar-thy-neighbor currency wars.

Everyone knows it, they just can’t do it

(Three Arrows of Abenomics is a good proposal, but is not working that well. Source:


Since Abe Shinzo became the Japanese PM in 2012, his “Three Arrows” – including aggressive monetary easing, fiscal expansion, and structural reforms has been encouraging to global investors, as it brought hopes that Japan might get itself out of the economic stagnation. However, inherent structural obstacles have impeded Abe from carrying out his “third arrow”. Even LDP itself had internal disagreements over the consumption tax hikes, how is it supposed to address tougher issues, such as reforms of health insurance, labor markets and Japanese companies’ corporate governance? At the end of the day, three arrows were explicitly merged into one single arrow (monetary easing), which is also addictive as it addressed short-term pains and served as a placebo. Sadly, Japan is not alone on this front. In fact, most governments are more than willing to increase the doses of monetary easing, and sugarcoat it as “buying time for reforms”. The result is slumping further into the dilemma of monetary policy making, and led to decreasing effectiveness of monetary policy. More aggressive actions have been taken by central banks, such as negative interest rates and more asset purchases. What accompanies these aggressive moves were inaction on the fiscal front and slower-than-expected structural reforms.

G20 Shanghai meeting may be a turning point 

The US Treasury has been urging Japan to accelerate structural reforms for long, yet Japan tried to negotiate with the US to reach a consensus on further monetary easing. Since 2013, Jacob Lew of US Treasury has been warning Japan to abide by global consensus and not to spread currency war’s “moral hazard” across the globe.

Since the PBOC unilaterally set the RMB lower during the “August-11th currency regime change” last year, “moral hazards” of global currencies’ depreciation have been escalating and repeatedly led to global market jitters. US also realized the danger of risk transmission from the currency market to global financial markets. Such risks have endangered the process of global structural reforms and further aggravate the imbalances of the global economy.

Since the beginning of 2016, the US Treasury has been communicating non-stop with G20 members, especially with China, Japan and the EU, in order to reduce competitive currency depreciation among nations; G7 countries were also asked not to set currency-based targets, but rather focus on rejuvenating economic growth. Thus since the G20 Treasury Secretary Meetings in Shanghai this February, most G7 members except Japan have changed their approaches towards monetary policy. US and China have also reached a consensus, where China have bought time for reform rather than RMB volatility. Japan have been more unfortunate on this front – though Taro Aso have repeatedly trying to reach an agreement with Jacob Lew to gather support for more monetary easing. US eventually  decided not to give in, a move to not only deter Japan from further easing, but also to stress the importance of structural reforms towards both EU and China. As EU has refrained from more easing, market participants have been betting on yen’s strength.

(Everyone smiling during the G20 meeting, but the conflicts were evident. Photo source: Xinhua)


On April 15th’s second G20 Treasury Ministers and central bank governors’ gathering, Jacob Lew  responded to Aso’s claims of yen strength that currency market remains orderly and Japan should focus on boosting domestic demand instead of exports ( The statement rejects further room for BoJ to ease, which also leads to Japan being punished by strong speculative forces betting on yen appreciation.

The BOJ has found itself in a precarious situation – no matter what they say and what policies they may carry out, the market is still pushing yen into the opposite direction of what policy endeavors it to be. In the past such phenomenon has happened repeatedly in EM countries where policy credibility and institutional stability were rather weak. Some of these EM currencies have a fixed peg with the USD, which eventually collapsed when the market found out it lost control over its currency. But this phenomenon is rather rare in DM economies, as they have rather stabler policies and better institutions. Mario Draghi’s “whatever it takes” is another example that DM central banks normally have the power to affect the market. But what happens now is that BOJ’s monetary policy is gradually losing its credibility, which in essence forced Abe to carry out rest of his “arrows”.

(Net long yen exposure has come back since early 2016, source: Bloomberg)


Contagion risk to China and EU

While BOJ is facing increasing pressure from the currency market, other central banks may not be immune to the risk of market betting against themselves. ECB and PBOC may also encounter such risks going forward as they have to rely on unorthodox policy tools and forward guidance to keep the economy running.

EU looks considerably more lenient on currency appreciation, as the German economy can still sustain itself via exports and there is little incentive for ECB to intervene the currency market for now. At least when Japan is concerned about the two arrows of Abe, Europe has at least tried to implement structural reforms. But the real risk is that interest rate spread’s influence on exchange rates is diminishing. The effectiveness of monetary policy making is to affect expectations of interest rate spread, which in turn leads to changes in currency rate expectations. If the market starts to bet on DM economies having “no room” to further ease, volatility of major economies’ currencies will increase rapidly, which not only impairs the room for the real economy to recover, but also transmits the risk to other asset classes.

China’s basket referencing is also under wide scrutiny, particularly when the JPY and EUR is appreciating, which gives further pressure on RMB’s appreciation. Although this might be what the US is desiring, the market is suspecting that China has returned to a virtual peg with the USD.

(CFETS, the official RMB basket shows a mild depreciation since the beginning of the year, source: CFETS)


In essence, China, EU and Japan all needs a benevolent currency environment to make room for structural reforms, all of which requires the US to compromise temporarily. So far, however, the patience of US is dwindling, as they are demanding more structural reforms in these countries instead of monetary easing/currency depreciation.

Temporary halt of currency war? Not necessarily.

The latest semiannual report by the US Treasury in April on International Economic and Exchange Rates stated that China, Japan, South Korea and Germany may have exploited foreign exchange rate policies that have led to unfair competitive advantages, putting these economies on the “monitoring list”. The main reason is that these countries enjoyed a huge trade surplus against the US. Following the Trade Facilitation and Trade Enforcement Act of 2015, there are three main criteria- 1) a significant bilateral trade surplus with the US; 2) a material current account surplus; and 3) engaged in persistent one-sided intervention in the FX market. So far, none of the countries have satisfied all three criteria, which will lead to “enhanced bilateral engagement”, which may lead to denying access to PIC financing, exclusion from US government procurement, etc. Thus it is not a DM-EM question any more, but a question of US’ security and national interests.

Global economic recovery is by no means facing a cyclical obstacle, but it rather needs to address adamant structural issues. Major economic powers need to reduce its over-reliance on monetary policy, address the issue of excessive debt as well as to strengthen regional and global policy coordination. Just as what Stevens, Head of RBA, has stated:

“Monetary policy alone hasn’t been, and isn’t, able to generated sustained growth to the extent people desire. Maybe we need to be clearer about what we can’t do. Monetary solutions are for monetary problems. If there are other problems in the underlying working of the economy, central banks won’t be able to solve these.”

China’s reform roadmap is on a right path – on the one hand it will carry out supply-side reforms, while on the other hand it will maintain an accommodating environment from both monetary and fiscal front to support structural reforms. The issue thus is not the design of the reform plans, but rather who will do it and whether China is able to execute.

Meanwhile, global leaders need to make up their minds to address structural issues instead of demand-side monetary easing. There is a cap for further monetary easing, and it is necessary for major economies to abandon beggar-thy-neighbor policies but to redefine and restructure global policy coordination. Structural reforms cannot be confined to a single nation but rather worldwide. It is a critical time now for G20 nations to act and make tough choices.




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