MORGAN STANLEY: Japan Has Changed The Game, And Now There Really Could Be A Currency War

To refresh, what this phrase means is countries are trying to weaken their currencies to boost exports.

The phrase came about in 2010, when the Brazilian finance minister said that the Fed's QEII program was the start of a currency war.

In a new note out, Morgan Stanley's Manoj Pradhan argues that there wasn't a currency war then... but that there might be one now.

It starts out with a classic line.

Andy Warhol famously said “In the future, everyone will be world-famous for 15 minutes”. Guido Mantega, Brazil’s finance minister, has clearly outperformed that benchmark. His concern in 2010 that the Fed was starting a “currency war”, using QE to weaken the US dollar against EM currencies, resonated with many in the emerging world and many in developed economies too.

Pradhan goes onto argue that Mantega was wrong. QE was about defeating deflation and boosting asset prices. It was not about weakening the dollar.

But while there might not have been a currency war in 2010, there might be one today, thanks to Japan.

Japanese policy has changed the game: Japan’s policy-makers now want to end deflation and reinvigorate investment. Given the export-orientation of Japan’s economy, the role of the yen is likely to be much stronger for Japan than the dollar is for the US economy. This creates the risk of bringing into the fray the one, all-important element that was missing before – competitive depreciation. Any further monetary expansion by a major central bank may now prompt Japan’s policy-makers to take retaliatory action to weaken the yen. If they do, EM currency appreciation would be collateral damage.

Already we've seen German leaders complain about Japanese monetary policy, which is a sign that they're irritated by the effects of a rival exporter weakening its currency so much.

Meanwhile, the Euro surges, as the ECB sits idly by. Will the ECB switch back into easing mode to counter?