Currency War

Topics: Foreign exchange market, Currency, Monetary policy Pages: 18 (6026 words) Published: February 21, 2011
Currency war
From Wikipedia, the free encyclopedia

Currency war involves states competing against each other on the foreign exchange markets to achieve a relatively low exchange rate, in order to boost their exports. Currency war, also known as Competitive devaluation, is a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their home currency, so as to help their domestic industry. Competitive devaluation has been rare through most of history as even at times when a system of fixed exchanges rates has not been in place, countries have generally preferred to maintain a high value for their currency or have been content to allow its value to be set by the markets. A widely recognized episode of currency war occurred in the 1930s. According to Brazil's finance minister, Guido Mantega, and to several financial journalists, a global currency war in on the verge of erupting in 2010, though this has been disputed by other commentators. The currency war of the 1930s is generally considered to have been an adverse situation for all concerned; with all participants suffering as unpredictable changes in exchange rates reduced international trade. The 2010 outbreak of competitive devaluation is being pursued by different mechanism than was the case in the 1930s and opinion among economists is divided as to whether it will have a net negative effect on the global economy.

Reasons for intentional devaluation

During most historical periods it’s rare for governments to intentionally devalue their currencies. For a country with low levels of unemployment, it’s more common to consider a strong currency desirable. A high exchange rate means a nation's citizens will enjoy more purchasing power, both when they buy foreign goods and when they travel abroad. It helps keep inflation down. A strong currency has often been considered a mark of prestige. However when a country is suffering from high unemployment or wishes to pursue a policy of export led growth, a lower exchange rate can be viewed as a potential solution. A lower value for the home currency will raise the price for imports while reducing the price for exports. This encourages more production to occur domestically, which raises employment and GDP. Devaluation can be especially attractive as a solution to unemployment when other options like increased public spending are ruled out due to high public debt and also when a country has a balance of payments imbalance which devaluation would help correct. A reason for preferring devaluation common among emerging economies is that maintaining a relatively low exchange rate helps them build up their foreign exchange reserves, which can protect them against future financial crises. Page | 1

Mechanism for devaluation
The options a country has to effect devaluation vary depending on the nation in question and the arrangement of the International monetary system that prevails at the time they wish to devalue. During the 1930s, countries had relatively more direct control over their exchange rates through the actions of their central banks. Following the collapse of the Bretton Woods system in the early 1970s, markets have substantially increased in influence so unless a nation has very strong capital controls their exchange rate is essentially set by the markets. However a nations central bank can still intervene in the markets to effect a devaluation – if it sells its own currency to buy other currencies [1] then this will cause the value of its own currency to fall. Less directly, if a central bank indulges in quantitative easing as had became common in 2009 and 2010, this tends to lead to a fall in the value of its currency even if the bank doesn't directly buy any foreign assets. A third method is for authorities simply to talk down the value of their currency, by hinting at future action that will discourage speculators from betting on a future rise,...

References: October 10, 2010, New York Times
Currency Rift With China Exposes Shifting Clout
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