The US dollar is at an inflection point. Can the dollar’s cycle continue in the face of convergent economic fundamentals and central bank coordination?
The currency war “truce” at the G20 meeting in February of this year has effectively placed political pressure on Japan to refrain from further depreciation of the yen. We investigate whether this has frozen USDJPY at its “fair value”. Although a naïve reading of PPP figures suggests that the outcome is reasonable, adjustment for productivity differentials suggests that the yen is now heavily overvalued versus the dollar, with attendant negative consequences for the Japanese economy.
• The US has had a long standing concern about what it perceives to be excessive “currency manipulation” on the part of some countries, especially in Asia. This concern is primarily driven by the large and persistent US current account deficit, which will necessitate significant relative currency adjustments for it to at least begin to unwind.
• A problem with this view emanating from US officialdom is that the pass-through effects between currency movements and domestic inflation in the US has been shown to be weak, thus making the process of adjustment more drawn out at best, and ineffective at worst.