Welcome to Bretton Woods III
The original Bretton Woods system of fixed exchange rates broke down in the early 1970s when the US ditched the gold standard. But in the post-Asia crisis period, the Bretton Woods II surfaced, popularised by Garber, Dooley and Folkerts-Landau, and argued that Asian countries (the periphery) committed to export-led growth through an undervalued exchange rate would export capital to the US (the core).
We are at the early stages of a third phase of this transition toward a Bretton Woods III system whereby the core remains the same (ie the US) while the periphery is once again shifting back towards Europe and Japan. Instead of exports, the focus from Europe and Japan is on importing inflation (or preventing further disinflation/deflation) through currency weakness.
NIRP is the weapon of choice to help force capital away from the periphery and toward the deeper and more liquid capital market of the core. This is not a race between European and Japanese central banks as a form of competitive monetary policy easing, instead it reflects the difficulty of forcing sticky domestic investors to shift money abroad or spend more through negative interest rates.
The problem with the above is that: 1) as central banks search for the lower bound on NIRP, we could see disorderly outflow of funds from Europe and Japan instead of an orderly trickle; and 2) the US Fed, having delivered lift-off, remains keen to normalise policy further and does not have the stomach for US dollar strength that would prevent it from achieving the 2% inflation goal.
In an environment where the goals of Europe/Japan and the US are incompatible, it is hard to see a coordinated Plaza Agreement/Lourve Accord at the G7, let alone the G20. The spirit of the current G7 agreement is still being adhered to as monetary policies remain oriented towards meeting “domestic objectives using domestic instruments” and not targeting exchange rates.
The more likely scenario is that Europe/Japan’s experiment in testing the lower NIRP bound will lead to significant dollar strength that is both volatile and disorderly. This is likely to bring about eventual co-ordination, but the journey has just begun. Fasten your seatbelts, it’s gonna be a bumpy ride.