Currency Wars and the Making of the Next Financial Crisis in the Global Economy

The Recent Currency Wars

The recent drop in the value of several emerging market currencies coupled with the fact that the BOJ (Bank of Japan) has embarked on extreme monetary stimulus and the US Federal Reserve’s unlimited bond buying spree have rekindled fears of a currency war among the currencies of the world. Added to this scenario is the fact that the Chinese Yuan is also depreciating against the major currencies leading to the markets around the world betting on which currency is the next to join in the currency war.

Of particular importance is the sharp drop in the value of the Indian Rupee, the South African Rand, and the Indonesian Rupiah over the last few days. All these moves come in the backdrop of worsening economic conditions around the world, which means that countries intentionally debase their currencies to remain competitive. This and the fact that central banks around the world are engaged in unlimited bond buying and monetary easing means that the surfeit of liquidity in the system is making the currencies lose value because there are too many of them circulating in the market.

The Nature of Currency Wars

A currency war by definition starts when a country intentionally makes moves that lowers or increases its value when compared with other currencies. This is done either as a means to increase export competitiveness or to discourage imports.

Exports earn more money for the same dollar value when currencies depreciate, as the value of the currency is lower when compared to the dollar making the proceeds from exports get more local currency value. On the other hand, imports are made more expensive as the same dollars need more local currencies values to buy the goods and services. This is the reason why many countries usually embark on currency wars because when the global trade and macroeconomic situation is weak, they need more exports and one way of increasing exports is to lower the value of their currencies.

The other reason why currency wars take place is that countries around the world are engaging in monetary expansion, which is a euphemism for printing money. When central banks print money in local currencies to monetize the debt or to convert the debt into assets held by them, the result is too much liquidity leading to the value of the currency being lowered and inflation which is another topic altogether.

The Consequences of Currency Wars

Many economists fear that the current round of competitive monetary expansion would result in a protracted round of currency wars which might even provoke retaliations from other countries and lead to conflicts both in the markets and in the geopolitical sense.

For instance, China has long maintained its value of the Yuan low so that its exports are competitive and it has done this despite opposition from the US and other trading partners who have always expressed their concerns about the Chinese Yuan being undervalued.

With so many countries around the world now jumping into the currency wars arena, it is high time for order to be restored as such chaotic conditions in the currency markets do not augur well for the global economic recovery. This is the reason why the IMF (International Monetary Fund) and the World Bank have called upon member countries to desist from currency wars and have explicitly warned countries from doing so. However, this does not seem to have had the desired effect on the members of the global economic system as can be seen from the recent wild gyrations and fluctuations in the values of the global currencies.

Concluding Thoughts

Finally, in the absence of growth in the global economy, currency wars are inevitable and hence, it is in the interests of all the nations to recover from the crisis without a beggar thy neighbor attitude, which would only worsen the situation for everybody. More than anything else, it is for this reason that currency wars must be avoided.

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Managerial Economics