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 or 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.
For the last few years the U.S. has been the big loser in the currency wars, as higher interest rates pushed the dollar up against its peers. Now it's fighting back, with officials from the administration of President Donald Trump accusing Germany and Japan of gaining an advantage by keeping currencies weak. 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 consumer prices that can cripple spending and sap growth. The battle erupted again after China’s surprise devaluation of the yuan roiled markets in August 2015 and the currency slid further in early 2016. The moves raised concern that China would weaken the yuan to revive a slowing economy, prompting denials from Chinese officials. Japan also jolted markets by introducing negative interest rates in 2016, following the European Central Bank’s move below zero in 2014. At least 22 countries cut interest rates in 2016, with nations from Australia to Norway easing monetary policy.
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 2015 devaluation of the 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 the political shifts, that could now change. As more countries embrace 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 timeline of the Trump team's currency-market rhetoric and a story on the evolution of currency war language in G-20 statements.
- “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 strong dollar policy, negative interest rates and currency pegs.
First published Feb. 10, 2015
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