Currency War

China has long prevented its currency, the yuan, from appreciating alongside other currencies.

There is a growing debate over the possibility that the world is wrapping itself up in a currency war. Rich countries with weak growth and high levels of unemployment are looking for ways to stimulate their economies. Central banks in the U.S., as well as in Europe and Japan, continue to maintain historically low interest rates while looking for additional ways to inject even more resources into their economies, partly in an effort to provide temporary help in facing bank related problems or distrust of the markets; thus, central banks have bought securities issued by the States and have loaned large sums to troubled banks.

The aim of low interest rates and the injection of resources is for banks to avoid falling into more problems and in turn affecting other banks. In other words, the aim is that inflation — which in various countries is creeping toward historic lows — increases a little. Why would the world want inflation to increase? Because if deflation occurs again, meaning that prices tend to drop instead of rise, this too could cause problems. One problem, among others, is that current interest rates (nominal interest rates minus inflation) would become extremely high, thus curbing credit and setting back the economic recuperation.

Now, this injection of capital also tends to cause the currency of the aforementioned countries to lose value compared to others. For example, the dollar has depreciated in comparison to many other currencies in the world and there are those who believe that this is a voluntary movement by the U.S. to gain competitiveness: Export more products to the rest of the world, recuperate partial growth and reduce commercial deficit.

U.S. officials insist they are not seeking a “weak dollar,” and are worried little by current trends that may seem to suggest otherwise.

In parallel, China has long prevented its currency, the yuan, from appreciating alongside other currencies, officially for fear that excess volatility in the exchange rate could affect the financial system; however, it may also be because it could curb massive Chinese exports or stimulate imports from the rest of the world. Meanwhile, Latin America has noticed that growing capital funds that once moved north are now being drawn in more and more by countries of the south with serious macroeconomic management such as Brazil, Colombia, Peru and Chile. This shift, which at first seems positive and would allow for cheaper financing, could also prove to be deceptive if defined by short term speculative capital, which would throw economies off balance and generate rapid currency appreciation. Instead, these countries are looking for ways to check these capital funds: hence, the price of fame.

Economic history shows that currency wars — the kind in which each country tries to devalue more than its neighbors in order to export more — usually end badly and without winners. As proof we have the crisis of the 1930s, which caused long recessions, high inflation, and was one of the factors that led to World War II. It would be convenient for the world to have exchange regulations as well as a coordinated monetary system, but the temptations of each country, internal political pressure and speeches of economic nationalism can only result in counterproductive protectionism.