Currency Devaluations Are an Undeclared War

Swiss franc bank notes inside a currency exchange store in London.

Swiss franc bank notes inside a currency exchange store in London.

Photographer: Chris Ratcliffe/Bloomberg

The global currency war is threatening to prove a silent killer.

So says David Woo, head of global rates and currencies research at Bank of America Merrill Lynch in New York.

While some question the existence of any conflict -- arguing that falling exchange rates merely reflect efforts by central banks to spur lackluster domestic economies -- Woo expresses concern.

“There is a growing consensus in the market that an unspoken currency war has broken out,” he said in a report to clients this week. “The reason why this is a war is that it is ultimately a zero-sum game -- someone gains only because someone else will lose.”

The standard view on war-mongering is that by easing monetary policy, central banks from Asia to Europe are hoping to weaken their currencies to boost exports and import prices. Trade rivals then retaliate, creating a spiral of devaluations as witnessed in the 1930s.

Just this week, Reserve Bank of Australia Governor Glenn Stevens said “a lower exchange rate is likely to be needed” after he unexpectedly cut interest rates to a record low.

Istanbul Meeting

With more than a dozen central banks injecting extra stimulus so far this year, currencies will be discussed when finance ministers and central bankers from the Group of 20 meet next week in Istanbul. For much of the past two years the G-20 has formally committed to refrain from targeting “exchange rates for competitive purposes.”

That leaves Woo, a former International Monetary Fund economist, declaring the war is one of “stealth” and warning the fallout from it is already roiling financial markets in a way undetected by most.

By measuring the volatility of currencies, which he calculates as the difference between the maximum and minimum exchange rate over a 26-week period, Woo estimates the dollar has been swinging about 20 percent against both the yen and the euro. In the past 15 years it was only higher following the collapse of Lehman Brothers Holdings Inc. in 2008.

A second gauge of volatility that weighs currencies based on the gross domestic product of 20 major economies delivers the third-highest reading in two decades, topped only by the Asian crisis of 1997-98 and Lehman’s demise, he said.

It is these fluctuations that are threatening to undermine the global economy more than some realize, Woo said.

First, they will make it costlier for companies to take out insurance against currency flows, eating into profit margins of exporters. More volatility may also force companies to focus more on their home markets, further reducing already lackluster international trade. Making foreign direct investments will also be less appealing, forcing up the cost of capital for those countries with current-account deficits.

Woo’s bottom line: “A weak currency might provide a short-term boost to the countries engaging in currency devaluation,” he said. “However, if everyone is playing the same game, all we will end up with is more and higher FX volatility. This in turn will likely exact a toll on global trade and capital flows.”

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