Analysis of Currency wars

First of all, we define currency wars as monetary and exchange rate policies designed by a country to lower the value of its currency. These are policies that put downward pressure on the country’s own currency and help to improve economic growth at the expense of growth in other countries. The term ‘Currency wars’ was introduced by Brazilian Finance Minister Guido Mantega to describe the 2010 move by the US and China to have the lowest value of their currencies.

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This effort was about lowering currency values, which aid exports by making them cheaper than other countries’ currencies. This is in perfect relationship with the theory of ‘Devaluation’ (whereby a country lowers the value of the currency to raise the money supply, stimulate exports and expand production) and the IS-LM macroeconomic model (whereby the government increases interest rates and incomes, which reduces investment and leads to a devaluation of the currency)1.

Secondly, the term ‘currency wars’ being mainly focused on the US and China leads us to analyzing it in three different angles: the US ‘side of the coin’, China and the rest of the world mainly Brazil (where the term originates from) and other emerging markets. In this way, we see that the US on one hand has adopted expansionary fiscal and monetary policy to devalue its currency (the dollar) through increasing spending; thereby increasing the debt, and by keeping the funds rate of the Federal Reserve Bank at virtually zero, which resulted into increased money supply and credit.

Of course this might be viewed differently (as a bad or good decision) according to the theory of ‘liquidity trap’ (whereby reducing the funds rate by the Fad is viewed by some people as having no problem in the future while others say it does have risk but suggest the central bank needs to push the real interest rate below zero to decrease the nominal interest rate towards zero, thus moderating the inflation rate which ultimately helps in getting out of the liquidity trap).

On the other hand, we find that China has been keeping its currency low by pegging it to the US dollar, along with a basket of other currencies; by buying US Treasuries, which limits the supply of dollars and hence gives it more strength than the yuan (China currency).

Additionally, there comes the side of Brazil and other emerging countries that are concerned because these currency wars (between the US and China) are driving their currencies higher than the US dollar. The result is that prices of commodities, such as oil, copper and iron, which are their primary exports, rise unexpectedly. This makes emerging market countries less competitive than usual and slows down their economic growth by causing inflations and unemployment. Here we can refer to the theory of AD-AS model of how output and inflation respond over time to exogenous changes in the economic environment.

Thirdly, when we analyze clearly we find that the US is the only country that feels strongly about China’s currency policy, which has led the US to obtain wider international support for its position against China’s policy but unfortunately they failed to obtain such support at the annual meetings of the International Monetary Fund (IMF) and the World Bank2. According to the New York Times, the meetings ended ‘with a tepid statement that made only fleeting and indirect references to the simmering currency tensions’. Following the meetings, the US vowed to increase the pressure on China, and the debate continued at the G20 meeting in Seoul in November whereby the ‘pressure on China to intervene on its renminbi (yuan) currency has been a consistent feature of G20 and G8 summits over the past few years, the US arguing that an intentionally undervalued renminbi (yuan) unfairly supports Chinese exports’3.

Furthermore, we understand that ‘Currency wars’ just like trade wars; they are very destructive if they are not controlled very well. This is because naturally, any war must have winners and losers. If we apply this on our study we find that not everyone can depress their currency’s value and increase their exports. That’s totally impossible and that’s exactly the reason why if we go back to the 1930s, many nations sought advantage by depressing their currencies to try to improve their competitiveness, but with exchange depreciation just to raise domestic prices, the ending result for one country was a loss for all (the countries). Mutual losses were experienced or known (on the surface) since there was tariff retaliation and competitive depreciation of the currencies.

Furthermore, we can add on that these ‘currency wars’ are certain in both developed and developing countries but their reasons and motivations are of course different. For example in the West, the recovery has been slow moving, and countries have injected huge amounts of money into their economies in order reverse the situation. This put downward pressures on their currencies and augmented their hopes of refining exports. On the contrary, emerging economies are improving faster than the Westerns, and capital is flowing into their countries, especially in Asia and Latin America where we find upward pressures on their currencies but still worry that the increase in the value of their currencies will be so rapid that it might damage their export-driven growth strategy and because of this they want to overturn that increasing pressure4.

Further still, individual countries at the IMF and World Bank meetings couldn’t agree on a way forward about the US and China issue simply because they are just opposed to seeing the US dollar falling against the Yuan which has happened recently, because it hurts the value of their own/individual currencies. They understand that if the Federal Reserve continues pushing the US currency down with its money policies of taking interest rates nearly at zero and extensive expansions in money supply; it will affect their economies which are also struggling to maintain their status on the global market.

From the above, we find a detailed explanation in the ‘BBC Financial News’ titled “Currency wars threaten global economic recovery” whereby it states that “in recent months a string of countries, from Japan to Switzerland, Colombia to Israel, have tried to drive down the value of their currencies. Some experts call it “competitive devaluation”. Others, though, argue that it is nothing short of a currency war – and far from boosting global recovery, it threatens to undermine it”5.