Currency_war_week in review

Are We In A Global Currency War?

In Business and Currency by Continental StaffLeave a Comment

Lately dire predictions of an escalating currency war with the potential to disrupt the global economy have been flashing across newscasts. Currency wars are serious, they have destructive economic consequences and potentially deadly political repercussions as well. A currency war led to a trade war in the 1930’s which (arguably) led to the Second World War – a point the doomsayers are quick to make. But is the sky really falling: is a currency war really looming?

What is a Currency War?

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Those who say that we are in the midst (or perhaps on the verge) of a currency war argue that central banks across the world are purposefully devaluing their currency. Currency exchange rates have tangible economic effects. When a currency drops in value; imports become more expensive while exports become more competitive – boosting the domestic manufacturing sector – and any debt owed in that currency becomes cheaper. All of these outcomes are compelling reasons for a central bank to artificially suppress the value of its currency.

Are we in a currency war?

It is no secret that central banks across the world have initiated policies that have resulted in the devaluation of their currencies. The ECB’s recent implementation of QE (quantitative easing) to the tune of €60 billion per month immediately dropped the euro to a 12 year low of nearly 1.05 USD. The Bank of Canada’s snap interest rate cut earlier this year took the world by surprise and the loonie fell accordingly against the USD (although it remained strong against the tumbling euro). Canada and the EU are not alone; Korea, Sweden, Australia and China and almost 20 other countries have all cut interest rates, but of course none would ever publicly admit to trying to influence the FX market.

As recently as 2010 Brazil accused the United States of engaging in currency wars when the worlds largest economy was still in the midst of its own QE program. Critics, like Brazil and China, argue that the Fed kept the dollar low to give the country’s struggling manufacturing industry a much needed boost, and to devalue the country’s growing debt to China. Interest rates in the US are still at rock bottom, but recent hints from the Fed signal that the US could raise interest rates in the coming months. However, if we are on the brink of an all out currency war the Fed might have to rethink its position. Right now American’s are enjoying the dollar’s strength, the US economy is growing, unemployment is down and the dollar’s purchasing power abroad is strong. But while the EU doesn’t present a major threat to American economic supremacy, China does, and the world’s second largest economy has thus far largely refrained from currency warfare. But this could change.

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China missed its growth targets last year and recently set a new goal of just 7% growth in 2015 – the lowest level in a quarter of a century. Already house prices in China have declined year on year by nearly 6%, and prices fell in 66 of China’s biggest cities. Adding to economists’ fears; industrial production, retail sales and investment are also down. China simply can’t afford to miss its target. With central banks across the world dropping interest rates and implementing QE– including regional rival Japan’s very aggressive program – China’s already bruised economy may have a more difficult time competing. Purposefully devaluing their currency could be their only option.

China is no stranger to currency manipulation, the Asian giant resisted natural upward pressure on its currency throughout the the early 2000’s to boost exports and the country’s manufacturing sector exploded. If China devalues its currency then the US would have no choice – it too would have to devalue its currency. The country is already suffering due to the dollars new-found strength – exports are down and imports are cheap. Maintaining a high value dollar would be economic suicide – the recent much heralded manufacturing renaissance that has symbolized America’s successful economic recovery would be strained to the breaking point.

But are we really in a currency war?

FX rates, as we showed in a previous article, are the result of much more than just GDP or other indicators of economic performance. Central bank policies can have a profound affect on FX by raising or lowering interest rates, implementing QE (quantitative easing) or through other policies.

Whether central banks in Europe, North America and Asia are engaging in currency wars is up for debate, but some things are clear; interest rates are being rolled back across the world and major currencies like the euro, Canadian dollar and yen are falling. This has caused investors to seek refuge in the dollar causing the currency to rise even further against the other major currencies.

Besides, it’s not as if Canada, the eurozone or Japan do not have ample justification to slash interest rates and implement QE. Japan’s economy has suffered recession after recession, oil prices have hit Canada hard (especially in Alberta) and the eurozone has been thrown from one crisis into another for the last half-decade. Falling exchange rates are simply the unintended, but not completely unwelcome, by-product of falling commodity prices, a frightened market pulling out of unstable currencies and the central bank policies that are necessary to restart global economies.

There is not enough evidence to suggest that the worlds central banks are engaged in dangerous and irresponsible games of chicken with their currencies. So, to be clear, no we are not in a global currency war.

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