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Japan's Economic Plan May Be Bad News For Everyone Else

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Moves taken by Japan's central bank are raising fears that the world could face what's called a "currency war." The measures, announced Tuesday, are designed to flood Japan's moribund economy with money and encourage businesses and consumers to spend more.

Steps like these have been tried again and again by countries all over the world — including the U.S. — in recent years, with mixed success.

What's Wrong With Pouring Money Into The Problem?

The U.S. Federal Reserve and central banks of other nations have been pouring money into their financial systems for several years now in an effort to stimulate their economies. These measures haven't managed to bring back boom times, but senior fellow Jacob Kirkegaard of the Peterson Institute for International Economics says things would have been a lot worse without them.

"Together with many of the other emergency measures, they've been instrumental in avoiding that the Great Recession turn into another Great Depression," he says. "So they basically helped us avoid the 1930s, in my opinion."

The policies pursued by central banks have been controversial. A common complaint is they are inflationary: So much money is sloshing around that prices will soar once the global economy improves. Kirkegaard says that fear simply hasn't been borne out.

"I just don't think that that is a credible argument when we still have the levels of unemployment and low-capacity utilization in general that we see in pretty much all of the industrial world," he says.

But the controversies don't stop there. The policies being pursued by the Bank of Japan have exposed a level of friction among the world's major economies and generated talk of what economists call "competitive devaluation."

"I think the biggest danger is ... actually potentially a currency war," investor George Soros said on CNBC Thursday.

German Chancellor Angela Merkel voiced concerns about Japan's policies, too, at the annual World Economic Forum summit in Davos, Switzerland.

A Potential Race To The Bottom

Japan has been mired in an economic slump for two decades, and new Prime Minister Shinzo Abe has made clear he thinks the way to stimulate growth is by exporting more.

"They feel that the only way they can grow their economy is by increasing exports, and one of the ways of increasing exports is by depreciating its own currency," says California State University economist Sung Won Sohn.

In other words, Japan has decided that its currency, the yen, is too strong and that weakening it will make its exports cheaper and allow the country to sell more goods overseas.

It's the kind of strategy that countries sometimes practice but rarely acknowledge publicly because it's so controversial. A country that weakens its currency may export more, but the move undercuts competing countries, whose goods become relatively more expensive. Sohn says sooner or later those other countries tend to retaliate by weakening their own currencies.

"If you can devalue your currency and not have other countries respond, then obviously you gain your market share," he says, "but historically, that's not what's going to happen — other countries will respond."

There are already signs the weakening yen is hurting exporters in South Korea, whose cars and electronic goods compete with Japan's. Korean officials have warned they're considering how to respond.

No Guarantees

But Sara Johnson, senior research director of global economics at IHS Global Insight, says it's unlikely countries will wage a full-fledged currency war. For one thing, countries pay a price when their currencies fall. They may export more, but the things they import, like oil, also become more expensive.

"I think the idea of competitive devaluation has been overhyped," she says. "Certainly, central banks do not want to generate inflation by making imports more expensive."

Moreover, trying to lower the value of a country's currency can be more complicated than it sounds. For example, the Fed has been flooding the U.S. economy with money for several years, yet the U.S. dollar is still almost as strong as it was two years ago.

Copyright 2013 NPR. To see more, visit http://www.npr.org/.

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