What is a currency war?
A currency war is a deliberate escalation of currency devaluation policies between two or more countries. Each country is trying to stimulate its own economy. Currency prices fluctuate continuously in International currency exchange market. However, a currency war is marked by many countries participating in policy decisions aimed at devaluation of their currencies.
Nations devalue their currency to make their exports more attractive in the world market.
important issues
- A currency war is an escalation of currency devaluation aimed at improving one’s economic status. one on the world stage at the expense of the other
- The devaluation involves taking measures to strategically reduce the purchasing power of a country’s currency.
- Countries may implement such strategies to gain competitive advantages in global trade. and reduce the burden of sovereign debt
- However, the devaluation can have unintended consequences that can lead to self-defeat.
Understanding Currency Wars
in the currency war This is sometimes called a competitive devaluation. Countries devalue their currencies to make their exports more attractive in international markets. by effectively reducing the cost of export Therefore, the country’s products attract more international buyers. and by making imports more expensive A currency devaluation could have a positive effect on the country. Trade deficit.
The devaluation has also forced domestic consumers to look for local alternatives to imported goods. This will boost the domestic industry. This combination of export-led growth and rising domestic demand often produces higher and faster employment. economic growth.
On the negative side, the devaluation of the currency could deteriorate the country’s productivity. This is because the import of capital equipment and machinery can be too expensive.
Economists view currency wars as detrimental to the global economy. This is because these back and forth actions by countries seeking competitive advantages can have unforeseen consequences, such as increased protectionism and trade barriers.
Are we in a currency war?
in the modern era of The floating exchange rate, the currency’s value is determined by market forces. However, currency depreciation is designed by the country’s central bank through economic policies that force the currency to fall.
Reducing interest rates is another strategy, quantitative easing (QE), where central banks buy large amounts of bonds or other market assets. These actions are not as revealing as the devaluation. But the effect may be the same.
The combination of private and public tactics creates more complexity than the currency wars of decades ago when fixed exchange rate It is widespread and the nation can devalue the currency through simple actions of reducing the “freeze” in which the currency is fixed.
‘Competitive Reduction’
“Currency wars” is not a loosely vague term in the world of economics and central banks, which prompted former Brazilian Finance Minister Guido Mantega to incite a hornet’s nest in September 2010 when he warned that an international currency war had collapsed. .
In recent times, countries that have adopted strategies to devalue their currencies have undermined their activities. by calling it weaker than that “Competitive currency devaluation”
In 2019, the US Federal Reserve Bank of England And the European Union are engaged in a “hidden currency war,” as reported on CNBC, with interest rates at their lowest. Devaluation is one of the only weapons central banks have left to boost their economies.
That same year After the Trump administration set tariffs on Chinese goods. China retaliated with its own tariffs. Including devaluation of their currency against the peg of the dollar. That could escalate the trade war into a currency war.
Why depreciate the money?
It may seem counterintuitive. But a strong currency doesn’t always have to be in a country’s best interests.
A weak domestic currency makes a country’s exports more competitive in the global market and simultaneously makes imports more expensive. The higher the volume of exports stimulated Economic growth while expensive imports have the same effect as consumers opt for local alternatives over imported products.
This improvement in trade generally translates to lower. current account deficit (or greater current account surplus) higher employment and faster GDP growth. The stimulating monetary policy, which often results in a weak currency, also has a positive effect on the country’s capital and housing markets. which will stimulate domestic consumption through Wealth effect.
beg your neighbor
Because it is not too difficult to pursue growth with currency depreciation. whether revealed or hidden It should come as no surprise that if Country A devalues its currency, Country B will soon follow. followed by country C, for example. This is the essence of competitive devaluation.
This phenomenon is also known as “Begging your neighbors, far from Shakespeare’s play that seems real, means the fact that countries that adhere to competitive devaluation policies are vigorously seeking their own interests to inflict damage on others
US dollar soared
When Brazilian Minister Mantega warned back in September 2010 about the currency war. He was talking about the growing turmoil in the foreign exchange market. sparked by new strategies used by many countries The US Federal Reserve’s (Fed) quantitative easing program weakened the dollar. China continues to crack down on the yuan And a number of Asian central banks have intervened to prevent their currencies from strengthening.
Surprisingly, the US dollar has remained strong against almost all major currencies since then into early 2020, with the trade weighted dollar. Trading indices at their highest level in over a decade
Then, in early 2020, the coronavirus outbreak broke out. The US dollar fell from its highs and continued to weaken. That’s just one side effect of the coronavirus pandemic. and the Fed’s actions to increase the money supply in response to it.
Strong US Dollar Policy
In general, the United States has followed suit. “The dollar is strong, a policy with varying degrees of success over the years. US economy It withstood the impact of a stronger dollar without much trouble, although one notable issue was the negative impact of the strong dollar on American multinationals’ earnings.
However, the situation of the United States special Because it is the largest economy in the world. and the US dollar is the world Reserve currency. A strong dollar adds to the attractiveness of the US. as a destination for Foreign direct investment (FDI) and foreign portfolio investment (FPI).
It should come as no surprise that the United States is the leading destination in both categories. The United States is also less dependent on exports than other countries. for economic growth due to their large consumer market the largest in the world
situation before covid
The dollar has strengthened in the years before the COVID-19 pandemic. because the United States Be the first major country to relax economic stimulus projects after being the first country to introduce QE measures
Waiting periods help the US economy Can respond positively to the US Federal Reserve’s QE program
Other global powers such as Japan and the European Union Re-joining the QE party relatively late, Canada, Australia and India, which have raised interest rates after the end of the month. The Great Recession of 2007-09 had to later ease monetary policy as growth momentum slowed.
Policy differences
while the United States Implement a strong dollar policy. Most of the rest of the world pursues simpler monetary policies. This discrepancy in monetary policy is a key reason for the dollar’s continued appreciation across the board.
The situation was aggravated by a number of factors:
- Economic growth in most regions is below historical norms. Many experts view this substandard growth as a result of the Great Recession.
- Most countries use alternatives. all to stimulate growth The interest rate is at a record low. With no further rate cuts and fiscal stimulus, it is not a controversial choice. A currency depreciation is the only remaining tool to fuel economic growth.
- sovereign bond yields For the short to medium term maturity has become negative for many countries. in a very low yield environment US Treasury Department received a lot of attention As a result, the demand for the dollar increased.
The 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 efforts to prevent economic troubles by devaluation of the Brazilian real have led to hyperinflation and undermined the country’s domestic economy.
So what are the negative effects of a currency war? A currency devaluation can lead to a decrease in productivity in the long run. This is because importing capital-intensive equipment and machinery is too expensive for local businesses. If depreciation doesn’t come with real structural reforms. The productivity will eventually be affected.
- The level of currency depreciation may be greater than required. which could eventually lead to higher inflation and Capital outflows.
- Currency wars can lead to greatness, protection and the building of trade barriers that hinder global trade.
- The devaluation of the competition may increase the value of the currency. volatility, which will lead to higher hedging costs for the company and may hinder Foreign investment.
bottom line
Although there is some evidence that may point to the controversy. But it doesn’t appear that the world is currently in the grip of the latest round of easy money wars. Many countries’ policies around the world show their efforts to combat the challenges of low-growth deflation. Rather than trying to steal the march on the competition by impersonating a weak currency.
Disclosure: The author does not hold positions in any of the securities mentioned in this article at the time of publication.
