Central bankers aren’t usually the ones who fight wars. But the global economy is a dangerous place, full of threats to prosperity. That’s given rise to the idea that there’s a tussle for competitive advantage going on, with each country brandishing its currency as a weapon. The standard view assumes policy makers are driving down exchange rates so that goods made by their exporters can be sold cheaper overseas, providing a jump-start to the economy at home. When other nations retaliate, it ignites a currency war. Central bankers say they’re not trying to pick fights. Rather, they’re cutting interest rates and taking other steps to stimulate growth. That creates spillover, however, as money flees for countries with higher rates, pushing currencies higher and hurting exporters. Whether intentional or not, these unspoken currency wars still create peril — and real winners and losers.
The battle erupted again after China’s surprise devaluation of the yuan in August and a further slide in the currency in early 2016. The moves raised concern that China would depreciate the yuan to revive a slowing economy, prompting denials from Chinese officials. Japan also jolted markets by introducing negative interest rates, following the European Central Bank’s move below zero in 2014. At least 24 countries cut interest rates last year, with nations from Canada to Singapore unexpectedly easing monetary policy. The currency wars have simmered for years as countries fought their way out of the recession triggered by the 2008 financial crisis. The U.S., Japan and Europe used bond-buying plans in addition to rate cuts to stimulate their economies. As the recovery limped along, central bankers eased policy further to ward off deflation, or a drop in prices that can cripple spending and sap growth. Who’s taking the hit? Mainly the U.S., where the first interest rate increase in almost a decade pushed the dollar higher against all 16 of its major peers in 2015.
Brazilian Finance Minister Guido Mantega gave the currency wars their name in 2010 when he denounced what he saw as the deliberate pursuit of weaker currencies. His country had been an early casualty in the fight, after lower U.S. rates sent money flowing into emerging markets, making Brazil’s commodity exports more expensive. One big winner was Japan, as the yen lost a third of its value against the dollar from the start of 2012 to the end of 2014, propelling profits for companies like Toyota. The most famous frenzy of competitive devaluations came during the Great Depression of the 1930s, as countries abandoned the gold standard that had pegged their currencies to the value of the metal. Until its collapse in 1971, the Bretton Woods system prevented a repeat of such beggar-thy-neighbor strategies by linking the value of many currencies to the dollar. Over the last decade, China has faced criticism for holding down the value of the yuan, as cheap goods helped transform the country into an exporting powerhouse.
The devaluation of the Chinese yuan — the first in more than two decades — prompted calls for clearer communication and a more united stance from the world’s central bankers. The G-20 group of countries regularly renews its pledge to refrain from competitive currency devaluations, though it has stopped short of criticizing any nation for doing so. With more countries embracing unconventional policies to protect their economies, the race to the bottom has taken on new momentum. The fallout from policy moves can rattle markets, whipsaw capital flows and fuel volatility. More countries have turned to currency pegs to stabilize their exchange rates, since currency fluctuations create uncertainty and can crimp investment. All the while, U.S. exporters have been feeling the pain, putting the recovery of the world’s largest economy at risk. There’s a debate about how long the world’s economies can fight, and how they might make peace in the currency wars.
The Reference Shelf
- A Bloomberg Brief newsletter explored the roots of the currency wars.
- “Currency Wars: The Making of the Next Global Crisis,” a book by Jim Rickards.
- Nouriel Roubini, an economist at the New York University Stern School of Business, explains the conflict in this article.
- A research paper on currency manipulation from Joseph Gagnon, a former official at the U.S. Federal Reserve and the U.S. Treasury.
- QuickTakes on the U.S. dollar, negative interest rates and currency pegs.
First published Feb. 10, 2015
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