In a candid moment in 1971, US Treasury Secretary John Connally bluntly informed his G10 counterparts that while the dollar may be America’s currency, it certainly posed a problem for others. This statement reflected the truth that the greenback, as the world’s primary reserve currency, primarily served US interests above all else.
Fast forward to today, and the dollar’s predominant role in global trade and finance has become more problematic for emerging market and developing economies (EMDEs) than for wealthier nations. The US Federal Reserve’s ongoing tightening cycle has disproportionately impacted EMDEs by sparking significant capital outflows, leading to currency fluctuations that exacerbate macroeconomic issues and inflate debt-servicing costs. Consequently, this limits the fiscal space for crucial public investment in these economies.
In recent years, diverging monetary policies between the Fed and other advanced economy central banks have caused exchange rate volatility even in wealthy countries. This disparity in policies has had particularly noticeable effects on Japan, which has resorted to intervening in foreign exchange markets to halt the yen’s rapid decline.
While the US Treasury refrained from labelling Japan as a currency manipulator, it did add them to the “monitoring list” due to concerns about potential unfair foreign exchange practices. This move underscored the challenges of coordinating international monetary policy amidst global risks arising from policy divergences.
Japan’s inclusion on the monitoring list stemmed from meeting two of the Treasury’s three criteria: a significant trade surplus with the US and a current account surplus surpassing three percent of GDP. Although the Japanese intervention in foreign exchange markets fell short of the threshold set by the Treasury, their proactive measures indicate a broader concern in global financial stability.
The ongoing battle to prop up the yen has seen Japanese authorities spending substantial amounts to counter its downward spiral since 2021 due to the interest rate gap between the US and Japan. Despite these efforts, the yen’s depreciation has persisted, leading to challenges in defending the currency within an interconnected global financial system.
The situation has further been complicated by investors turning to carry trades and rising bond yields, which continue to exert downward pressure on the yen. Moreover, the weakening yen has discouraged exporters from converting foreign earnings into the local currency, intensifying the exchange rate risks and reinforcing yen weakness.
The Japanese government’s repeated interventions to bolster the yen highlight the costs associated with monetary policy divergence on global stability and growth. While the weak yen may have boosted tourism and exports to the US, it has also introduced excessive exchange rate volatility, hampering corporate investment and increasing costs for industries and importers.
These disruptions have adversely impacted the Japanese economy, resulting in a slowdown in private consumption and a lower growth forecast for the fiscal year. Despite some signs of stabilization with narrowing interest rate differentials and a stronger yen, the volatility remains a significant concern for the Japanese government.
The recent policy divergence among major central banks has underscored the substantial global influence of the dollar. While previously seen as a concern only for EMDEs, Japan’s current plight reminds us that the dollar poses challenges for both wealthy and developing economies alike.
As we navigate this complex global financial landscape, it is imperative for policymakers to prioritize coordination and cooperation to mitigate the adverse effects of monetary policy divergences on international stability and economic growth.
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