CURRENCY WAR

What Is a Currency War?

A currency war is an escalation of currency devaluation policies among two or more nations,
each of which is trying to stimulate its own economy. Currency prices fluctuate constantly in
the foreign exchange market. However, a currency war is marked by a number of nations
simultaneously engaged in policy decisions aimed at devaluing their own currencies.

Nations devalue their currencies primarily to make their own exports more attractive on the
world market.

KEY TAKEAWAYS
 A currency war is a tit-for-tat policy of official currency devaluation aimed at improving
each nation's foreign trade competitiveness at the expense of other nations.
 A currency devaluation is a deliberate move to reduce the purchasing power of a
nation's own currency.
 Countries may pursue such a strategy to gain a competitive edge in global trade and
reduce their sovereign debt burden.
 Devaluation can have unintended consequences that are self-defeating. The worst of
these is inflation. The nation's consumers bear the burden of higher prices on imports.

Understanding Currency Wars

In a currency war, sometimes referred to as competitive devaluation, nations devalue their
currencies in order to make their own exports more attractive in markets abroad. By effectively
lowering the cost of their exports, the country's products become more appealing to overseas
buyers.

At the same time, the devaluation makes imports more expensive to the nation's own
consumers, forcing them to choose home-grown substitutes.

This combination of export-led growth and increased domestic demand usually contributes to
higher employment but faster economic growth.

It may also lower a nation's productivity. The nation's businesses may rely on imported
equipment and machinery to expand their production. If their own currency is devalued, those
imports may become prohibitively expensive.
Economists view currency wars as harmful to the global economy because these back-and-
forth actions by nations seeking a competitive advantage could have unforeseen adverse
consequences, such as increased protectionism and trade barriers.

Are We in a Currency War Now?

In the current era of floating exchange rates , currency values are determined primarily
by market forces. However, currency depreciation can be engineered by a
nation's central bank through economic policies that have the effect of reducing the
currency's value.

Reducing interest rates is one tactic. Another is quantitative easing (QE), in which a
central bank buys large quantities of bonds or other assets in the markets.

These actions are not as overt as currency devaluation but the effects may be the
same.

The combination of private and public strategies introduces more complexities than the
currency wars of decades ago when fixed exchange rates were prevalent and a nation
could devalue its currency by the simple act of lowering the "peg" to which its currency
was fixed.

Why Depreciate a Currency?

It may seem counter-intuitive, but a strong currency is not necessarily in a nation's best
interests.

A weak domestic currency makes a nation's exports more competitive in global

markets while simultaneously making imports more expensive. Higher export volumes
spur economic growth, while pricey imports have a similar effect because consumers
opt for local alternatives to imported products.

This improvement in the terms of trade generally translates into a lower current

account deficit (or a greater current account surplus), higher employment, and faster
growth in gross domestic product (GDP).

The stimulative monetary policies that usually result in a weak currency also have a
positive impact on the nation's capital and housing markets, which in turn boosts
domestic consumption through the wealth effect.
Currency war in the Great Depression[edit]
During the Great Depression of the 1930s, most countries abandoned the gold
standard. With widespread high unemployment, devaluations became common, a policy
that has frequently been described as "beggar thy neighbour",[28] in which countries
purportedly compete to export unemployment. However, because the effects of a
devaluation would soon be offset by a corresponding devaluation and in many cases
retaliatory tariffs or other barriers by trading partners, few nations would gain an
enduring advantage.
The exact starting date of the 1930s currency war is open to debate. [21] The three
principal parties were Britain, France, and the United States. For most of the 1920s the
three generally had coinciding interests; both the US and France supported Britain's
efforts to raise Sterling's value against market forces. Collaboration was aided by strong
personal friendships among the nations' central bankers, especially between
Britain's Montagu Norman and America's Benjamin Strong until the latter's early death
in 1928. Soon after the Wall Street Crash of 1929, France lost faith in Sterling as a
source of value and begun selling it heavily on the markets. From Britain's perspective
both France and the US were no longer playing by the rules of the gold standard.
Instead of allowing gold inflows to increase their money supplies (which would have
expanded those economies but reduced their trade surpluses) France and the US
began sterilising the inflows, building up hoards of gold. These factors contributed to the
Sterling crises of 1931; in September of that year Britain substantially devalued and
took the pound off the gold standard. For several years after this global trade was
disrupted by competitive devaluation and by retaliatory tariffs. The currency war of the
1930s is generally considered to have ended with the Tripartite monetary agreement of
1936.

Beggar Thy Neighbor

Since it is not too difficult to pursue growth through currency depreciation—whether

overt or covert—it should come as no surprise that if nation A devalues its currency,
nation B will soon follow suit, followed by nation C, and so on. This is the essence of
competitive devaluation.

The phenomenon is also known as "beggar thy neighbor," which is not a

Shakespearean turn of phrase but a national monetary policy of competitive
devaluation pursued to the detriment of other nations.

2000 to 2008[edit]
During the 1997 Asian crisis several Asian economies ran critically low on foreign
reserves, leaving them forced to accept harsh terms from the IMF, and often to accept
low prices for the forced sale of their assets. This shattered faith in free market thinking
among emerging economies, and from about 2000 they generally began intervening to
keep the value of their currencies low.[37] This enhanced their ability to pursue export led
growth strategies while at the same time building up foreign reserves so they would be
better protected against further crises. No currency war resulted because on the whole
advanced economies accepted this strategy—in the short term it had some benefits for
their citizens, who could buy cheap imports and thus enjoy a higher material standard of
living. The current account deficit of the US grew substantially, but until about 2007, the
consensus view among free market economists and policy makers like Alan Greenspan,
then Chairman of the Federal Reserve, and Paul O'Neill, US Treasury secretary, was
that the deficit was not a major reason for worry. [38]
This is not say there was no popular concern; by 2005 for example a chorus of US
executives along with trade union and mid-ranking government officials had been
speaking out about what they perceived to be unfair trade practices by China. [39]
Economists such as Michael P. Dooley, Peter M. Garber, and David Folkerts-Landau
described the new economic relationship between emerging economies and the US
as Bretton Woods II.

Currency war in 2013[edit]

In mid January 2013, Japan's central bank signalled the intention to launch an open ended bond
buying programme which would likely devalue the yen. This resulted in short lived but intense
period of alarm about the risk of a possible fresh round of currency war.
Numerous senior central bankers and finance ministers issued public warnings, the first being
Alexei Ulyukayev, the first deputy chairman at Russia's central bank. He was later joined by
many others including Park Jae-wan, the finance minister for South Korea, and by Jens
Weidmann, president of the Bundesbank. Weidmann held the view that interventions during the
2009–11 period were not intense enough to count as competitive devaluation, but that a
genuine currency war is now a real possibility.[78] Japan's economy minister Akira Amari has said
that the Bank of Japan's bond buying programme is intended to combat deflation, and not to
weaken the yen.[79]
In early February, ECB president Mario Draghi agreed that expansionary monetary policy like
QE have not been undertaken to deliberately cause devaluation. Draghi's statement did
however hint that the ECB may take action if the Euro continues to appreciate, and this saw the
value of the European currency fall considerably.[80] A mid February statement from the G7
affirmed the advanced economies commitment to avoid currency war. It was initially read by the
markets as an endorsement of Japan's actions, though later clarification suggested the US
would like Japan to tone down some of its language, specifically by not linking policies like QE
to an expressed desire to devalue the Yen.[81] Most commentators have asserted that if a new
round of competitive devaluation occurs it would be harmful for the global economy. However
some analysts have stated that Japan's planned actions could be in the long term interests of
the rest of the world; just as he did for the 2010–11 incident, economist Barry Eichengreen has
suggested that even if many other countries start intervening against their currencies it could
boost growth worldwide, as the effects would be similar to semi-coordinated global monetary
expansion. Other analysts have expressed skepticism about the risk of a war breaking out,
with Marc Chandler, chief currency strategist at Brown Brothers Harriman, advising that: "A real
currency war remains a remote possibility."[82] [83] [84] [85]
On 15 February, a statement issued from the G20 meeting of finance ministers and central bank
governors in Moscow affirmed that Japan would not face high level international criticism for its
planned monetary policy. In a remark endorsed by US Fed chairman Ben Bernanke, the IMF's
managing director Christine Lagarde said that recent concerns about a possible currency war
had been "overblown".[86] Paul Krugman has echoed Eichengreen's view that central
bank's unconventional monetary policy is best understood as a shared concern to boost growth,
not as currency war. Goldman Sachs strategist Kamakshya Trivedi has suggested that rising
stock markets imply that market players generally agree that central bank's actions are best
understood as monetary easing and not as competitive devaluation. Other analysts have
however continued to assert that ongoing tensions over currency valuation remain, with
currency war and even trade war still a significant risk. Central bank officials ranging from New
Zealand and Switzerland to China have made fresh statements about possible further
interventions against their currencies.[87][88][89][90]
Analyses has been published by currency strategists at RBS, scoring countries on their potential
to undertake intervention, measuring their relative intention to weaken their currency and their
capacity to do so. Ratings are based on the openness of a country's economy, export growth
and real effective exchange rate (REER) valuation, as well as the scope a country has to
weaken its currency without damaging its economy. As of January 2013, Indonesia, Thailand,
Malaysia, Chile and Sweden are the most willing and able to intervene, while the UK and New
Zealand are among the least.[91]
From March 2013, concerns over further currency war diminished, though in November several
journalists and analysts warned of a possible fresh outbreak. The likely principal source of
tension appeared to shift once again, this time not being the U.S. versus China or the Eurozone
versus Japan, but the U.S. versus Germany. In late October U.S. treasury officials had criticized
Germany for running an excessively large current account surplus, thus acting as a drag on the
global economy.[92] [93]

Currency war in 2015[edit]

A €60bn per month quantitative easing programme was launched in January 2015 by the
European Central Bank. While lowering the value of the Euro was not part of the programme's
official objectives, there was much speculation that the new Q.E. represents an escalation of
currency war, especially from analysts working in the FX markets. David Woo for example, a
managing director at Bank of America Merrill Lynch, stated there was a "growing consensus"
among market participants that states are indeed engaging in a stealthy currency war. A
Financial Times editorial however claimed that rhetoric about currency war was once again
misguided.[94] [95]
In August 2015, China devalued the yuan by just under 3%, partially due to a weakening export
figures of −8.3% in the previous month.[96] The drop in export is caused by the loss of
competitiveness against other major export countries including Japan and Germany, where the
currency had been drastically devalued during the previous quantitative easing operations. It
sparked a new round of devaluation among Asian currencies, including the Vietnam dong and
the Kazakhstan tenge.

Comparison between 1932 and 21st-century currency

wars[edit]
Both the 1930s and the outbreak of competitive devaluation that began in 2009 occurred during
global economic downturns. An important difference with the 2010s is that international traders
are much better able to hedge their exposures to exchange rate volatility because of more
sophisticated financial markets. A second difference is that the later period's devaluations were
invariably caused by nations expanding their money supplies by creating money to buy foreign
currency, in the case of direct interventions, or by creating money to inject into their domestic
economies, with quantitative easing. If all nations try to devalue at once, the net effect on
exchange rates could cancel out, leaving them largely unchanged, but the expansionary effect
of the interventions would remain. There has been no collaborative intent, but some economists
such as Berkeley's Barry Eichengreen and Goldman Sachs's Dominic Wilson have suggested
the net effect will be similar to semi-coordinated monetary expansion, which will help the global
economy.[48][98][99] James Zhan of the United Nations Conference on Trade and
Development (UNCTAD), however, warned in October 2010 that the fluctuations in exchange
rates were already causing corporations to scale back their international investments.[100]
Comparing the situation in 2010 with the currency war of the 1930s, Ambrose Evans-
Pritchard of The Daily Telegraph suggested a new currency war may be beneficial for countries
suffering from trade deficits. He noted that in the 1930s, it was countries with a big surplus that
were severely impacted once competitive devaluation began. He also suggested that overly-
confrontational tactics may backfire on the US by damaging the status of the dollar as a global
reserve currency.[101]
Ben Bernanke, chairman of the US Federal Reserve, also drew a comparison with competitive
devaluation in the interwar period, referring to the sterilisation of gold inflows by France and
America, which helped them sustain large trade surpluses but also caused deflationary pressure
on their trading partners, contributing to the Great Depression. Bernanke stated that the
example of the 1930s implies that the "pursuit of export-led growth cannot ultimately succeed if
the implications of that strategy for global growth and stability are not taken into account."[102]
In February 2013, Gavyn Davies for The Financial Times emphasized that a key difference
between the 1930s and the 21st-century outbreaks is that the former had some retaliations
between countries being carried out not by devaluations but by increases in import tariffs, which
tend to be much more disruptive to international trade.[33][103]

The U.S. Dollar's Surge

When Brazilian minister Mantega warned back in September 2010 about a currency
war, he was referring to the growing turmoil in foreign exchange markets, sparked by
new strategies adopted by several nations. The U.S. Federal Reserve's quantitative
easing program was weakening the dollar, China was continuing to suppress the value
of the yuan, and a number of Asian central banks had intervened to prevent their
currencies from appreciating.

Ironically, the U.S. dollar continued to appreciate against almost all major currencies
from then until early 2020, with the trade-weighted dollar Index trading at its highest
levels in more than a decade.
Then, in early 2020, the coronavirus pandemic struck. The U.S. dollar fell from its
heady heights and remained lower. That was just one side effect of the coronavirus
pandemic and the Fed's actions to increase the money supply in response to it.56

The U.S. Strong Dollar Policy

The U.S. has generally pursued a "strong dollar" policy for many years with varying
degrees of success. The U.S. economy withstood the effects of a stronger dollar
without too many problems, although one notable issue is the damage that a strong
dollar causes to the earnings of American expatriate workers.

However, the U.S. situation is unique. It is the world's largest economy and the U.S.
dollar is the global reserve currency. The strong dollar increases the attractiveness of
the U.S. as a destination for foreign direct investment (FDI) and foreign portfolio
investment (FPI).

Not surprisingly, the U.S. is a premier destination in both categories. The U.S. is also
less reliant on exports than most other nations for economic growth because of its giant
consumer market, by far the biggest in the world.

The Pre-COVID-19 Situation

The dollar surged in the years before the COVID-19 pandemic primarily because the
U.S. was the first major nation to unwind its monetary stimulus program, after being the
first one out of the gate to introduce QE.

The long lead-time enabled the U.S. economy to respond positively to the Federal
Reserve's successive rounds of QE programs.

Other global powerhouses like Japan and the European Union were relatively late to
the QE party. Canada, Australia, and India, which had raised interest rates soon after
the end of the Great Recession of 2007-09, had to subsequently ease its monetary
policy because growth momentum slowed.

Policy Divergence 
While the U.S. implemented its strong dollar policy, the rest of the world largely
pursued easier monetary policies. This divergence in monetary policy is the major
reason why the dollar continued to appreciate across the board.

The situation was exacerbated by a number of factors:

  Economic growth in most regions was below historical norms; many experts
attributed this sub-par growth to fallout from the Great Recession.7
 Most nations exhausted all other options to stimulate growth, with interest rates
at historic lows. With no further rate cuts possible and fiscal stimulus not a
controversial option, currency depreciation was the only tool remaining to boost
economic growth.
 Sovereign bond yields for short-term to medium-term maturities had turned
negative for a number of nations. In this extremely low-yield environment, U.S.
Treasuries attracted a great deal of interest, leading to more dollar demand.

Negative Effects of a Currency War

Currency depreciation is not a panacea for all economic problems. Brazil is a case in
point. The country's attempts to stave off its economic problems by devaluing the
Brazilian real created hyperinflation and destroyed the nation's domestic economy.

So what are the negative effects of a currency war? Currency devaluation may lower
productivity in the long term since imports of capital equipment and machinery become
too expensive for local businesses. If currency depreciation is not accompanied by
genuine structural reforms, productivity will eventually suffer.

Among the hazards:

 The degree of currency depreciation may be greater than what is desired, which
may cause rising inflation and capital outflows.
 Devaluation may lead to demands for greater protectionism and the erection of
trade barriers, which would impede global trade.
 Devaluation can increase the currency's volatility in the markets, which in turn
leads to higher hedging costs for companies and even a decline in foreign
investment.

Is India in a Currency War?

The U.S. Treasury Department placed India on its watchlist of currency manipulators in
April 2021. It cited India's outsized purchase of U.S. dollars as a possible attempt at
currency manipulation.10

India's rupee hit a record low of 1 U.S. dollar to 76.68 Indian rupees in April 2020, at
the start of the global economic crisis caused by the COVID-19 pandemic.11

The rupee has had a tumultuous history since its introduction in 1947 when the nation
achieved its independence. The nation moved from a dollar peg to a floating currency
in 1991 and, at the same time, devalued the currency to about 1 U.S. dollar to 25
rupees.12

The rupee's value remained relatively high through the first years of its remarkable
economic growth but faltered during the economic crisis of 2008-2009.13

As of Feb. 5, 2022, it remained relatively low at 1 U.S. dollar to 74.64 rupees.

The Bottom Line

It does not appear that the world is currently in the grips of a currency war. Recent
rounds of easy money policies by numerous countries represent efforts to combat the
challenges of a low-growth, deflationary environment, rather than an attempt to steal a
march on the competition through overt or surreptitious currency depreciation.

What Harm Can a Currency War Do?

A currency devaluation, deliberate or not, can damage a nation's economy by causing
inflation. If its imports rise in price. If it cannot replace those imports with locally
sourced products, the country's consumers simply get stuck with the bill for higher-
priced products.

A currency devaluation becomes a currency war when other countries respond with
their own devaluations, or with protectionist policies that have a similar effect on prices.
By forcing up prices on imports, each participating country may be worsening their
trade imbalances instead of improving them.

Does Chinese Currency Affect Trade Wars?

It may be the reverse: a trade war damages the currency of the country it targets.

The United States has an enormous trade gap  with China. That is, the U.S. imports
more than $271 billion worth of goods from China and exports nearly $72 billion, as of
June 2022.8

In 2020, then-President Donald Trump tried to correct that imbalance by imposing a raft
of tariffs on Chinese goods entering the U.S. This protectionist policy was aimed at
increasing the prices of Chinese goods and therefore making them less attractive to
U.S. buyers.

One effect was an apparent shift in U.S. manufacturing orders from China to other
Asian nations such as Vietnam. Another effect was a weakening of the Chinese
currency, the renminbi. Less demand for Chinese products led to less demand for the
Chinese currency.