Is Japan Prompting A 1930s-Like Currency War?

by: Investment Biker

Most countries abandoned the gold standard during the Great Depression of the 1930s. As a result, currencies of major economies lost their intrinsic value in quick succession. Under the gold standard, the currency value was fixed to the price of gold (NYSEARCA:GLD). This was a major disadvantage as it barred them from printing excess money. Countries that lost competitive advantage in the export market devalued their currencies to regain their market share. The following chart sets out the basic chronology of departures from the gold standard in the 10 European countries.

Source: Exchange Rates and Economic Recovery in the 1930, Barry Eichengreen and Jeffrey Sachs

  • July 1931 - Capital controls were imposed as protection measures in Austria and Germany when two major banks went bust.
  • September 1931, U.K. - The Bank of England removed Sterling from the gold standard, unleashing a wave of competitive devaluations.
  • September end 1931 - Norway, Denmark and Sweden followed U.K.
  • January 1934, USA - Gold was appropriated by FDR, following the passage of the Gold Reserve Act.
  • France, Germany and other Scandinavian countries also went of the gold standard by 1936.

There are two major lessons to be learned from the recession of the 1930s.

# Lesson 1: Moving out of gold standard was the only option to stay competitive during the 1930s. It was a matter of "timing" to make the switch.

# Lesson 2: Early movers benefited at the expense of those countries who experimented with gold regime for a longer time.


Industrial production of countries like the UK, Norway, Sweden, Denmark, Britain and Finland improved, while those of France and Germany suffered. Now let us compare the current scenario with the episode of 1930s.

  • Majority of the economies today have a flexible exchange rate mechanism, while in the 1930s it was dominated by gold standard.
  • However the origins of the crisis are still the same : Domestic issues. While it was high unemployment in UK during the 1930s that led to competitive devaluation, it is Japan's chronic deflation that the country is trying to address now.

Of late, currencies have increasingly become part of the global monetary policy debate. The Japanese yen (JPY) would be the most obvious case and the sharp weakening of the JPY (NYSEARCA:FXY) could have broader global policy implications. The new Japanese government looks committed to propel the economy out of deflation, given the range and extent of measures employed. The early resignation of the BoJ governor Shirakawa, making way for the smooth transition to a new governor, is another example of how the process is even running ahead of market expectations.


Finally if weaker yen remains the core of Japan's plans to revive its export market, risk of currency war looms higher. With anemic global growth and sluggish demand, any revival of Japan's export market would be at the loss of market share for other countries. Japanese companies like Toyota (NYSE:TM), Honda (NYSE:HMC), Toshiba and Mazda (OTCPK:MZDAY) would be the biggest winners at the expense of U.S. (NYSEARCA:SPY) companies like Ford (NYSE:F), General Motors, Caterpillar (NYSE:CAT), General Electric (NYSE:GE) and Deere (NYSE:DE).

Investment Implications: The outcome of Japanese (NYSEARCA:EWJ) actions would be fourfold - a) weaker yen b) growth in domestic demand c) negative interest rates and d) higher inflation. I have written in detail about the investment options available in my previous article "Asia and Japan's Reflation game." Now let us focus on the winners and losers.

  • As a country, Indonesia (NYSEARCA:EIDO) and Malaysia (NYSEARCA:EWM) would benefit from Japan's domestic demand in absolute terms, due to exports of fuel and lubricant products. However in terms of percentage of GDP, export-driven countries of Malaysia and Thailand would benefit the most. Korea (NYSEARCA:EWY) will be the biggest loser as it competes directly with Japan in the export market. Thailand (NYSEARCA:THD) would benefit as Japan exports high value-added auto parts to Thailand for assembly.
  • Gold: Falling bond real bond yields are good for gold-related products.
  • Emerging market currencies: The South African rand, Chinese renminbi (NYSEARCA:FXI) and the Indian rupee (NYSEARCA:ICN) offer both a real yield advantage and are currently undervalued.
  • Infrastructure and Utility companies with pricing linked to Inflation Index: include National Grid (NYSE:NGG), Ferrovial (OTC:FRRVF) and Severn Trent (OTCPK:SVTRF)
