currency war:
reasons &
reprecussions….
What is currency war?
Currency war, also known as competitive
devaluations, is a condition in International
affairs where countries seek to gain a trade
advantage over other countries by causing the
exchange rate of their currency to fall in relation
to other currencies. As the exchange rate of
country’s currency falls, exports become more
competitive in other countries, and imports into
the country become more and more expensive.
Both effects benefit the domestic industry, and
thus employment, which receives a boost in
demand from both domestic and foreign markets.
However, the price increases for import goods
are unpopular as they harm citizens’ purchasing
power, and when all countries adopt a similar
strategy. It can lead to general decline in
international trade, harming all countries.
Historically competitive devaluations have been
rare as countries have generally preferred to
maintain a high value for their currency.
Countries have generally allowed market forces
to work, or have participated in systems of
managed exchanges rates. An exception
occurred when a currency war broke out in
1930s’ when countries abandoned the gold
standard during the Great Depression and used
currency devaluations in an attempt to stimulate
their economies. Since this effectively pushes
unemployment overseas, trading partners quickly
retailed with their own devaluations. The period
is considered to have been an adverse situation
for all concerned, as unpredictable changes in
exchange rates reduced overall international
trade.
Reasons for currency war
The following are the major reasons for the
currency war:
1] To boost exports
On a world market, goods from one country
must compete with those from all other
countries. Car makers in America must
compete with car makers in Europe and
Japan. If the value of euro decreases against
the dollar, the price of the cars sold by
European manufacturers in America, in
dollars, will be effectively less expensive
than they were before.
On the other hand, a more valuable
currency makes exports relatively more
expensive for purchase in foreign markets.
In other words, exporters become more
competitive in a global market. Exports are
encouraged while imports are discouraged.
As the demand for a counrty’s exported
goods increases world wide, the price will
begin to rise, normalising the initial effect of
the devaluation and vice-versa.
2] To shrink trade deficits
Exports will increase and imports will
decrease due to exports becoming cheaper
and exports more expensive. This favors an
improved balance of payments as exports
increase and imports decrease, shrinking
trade deficits. President deficit are not
uncommon today, with the United States and
many other nations running president
imbalances year after year.
3] To reduce sovereign debt burdens
A government may be incentivized to
encourage a weak currency policy if it has a
lot of government-issued sovereign debt to
service on a regular basis. If debt payments
are fixed, a weaker currency makes these
payments effectively less expensive over
time.
When and how it started?
The first currency war started in the 1930’s.
Before world war 1 erupted, the value of
most major currencies was derived from the
price of gold. Countries pegged their currency
to the metal as this was known as ‘The Gold
Standard’. However, countries needed to
print more money to fund the staggering
costs of the war.
The gold standards provide stability in foreign
exchange markets, but it also provide limited
flexibility to governments. This promoted the
countries to abandon the gold standard to
help manage the huge financial burden of the
war, but once it was over most of them
craved the relative stability, it brought and
tried to return to it.
Historical Overview
Up to 1930
For millennia, going back to at least
the Classical period, governments have often
devalued their currency by reducing
its intrinsic value. Methods have included
reducing the percentage of gold in coins, or
substituting less precious metals for gold.
However, until the 19th century, the
proportion of the world's trade that occurred
between nations was very low, so exchanges
rates were not generally a matter of great
concern.
Currency war in the Great Depression
During the Great Depression of the 1930s,
most countries abandoned the gold standard.
With widespread high unemployment,
devaluations became common, a policy that
has frequently been described as "beggar thy
neighbour", in which countries purportedly
compete to export unemployment. However,
because the effects of a devaluation would
soon be offset by a corresponding
devaluation and in many cases retaliatory
tariffs or other barriers by trading partners,
few nations would gain an enduring
advantage.
Impact of currency war on
economies
If a country is successful in a currency war, its
exports will be cheaper, and imports will be
minimised. This would improve the trade
balance. If the interest rates were lowered to
devalue its currency, it might have the effect of
spurring economic growth. It should be noted
that there is always a risk that the country
would end up with high import costs. Higher
import costs can lead to higher inflation
If a country loses out in a currency war, its
exports will become more expensive, and
imports will become cheaper. This can affect
the trade balance and the domestic industries.
How do it impact investors?
When a country’s currency is devalued, the
value of returns for overseas investors might
drop. This expectation itself might lead
overseas investors to pull out. The outflow of
capital can lower asset prices.
When a country’s currency is expected to
appreciate, the value of returns for overseas
investors might increase. This expectation
might lead to an inflow of investments from
overseas investors. The inflow of capital can
boost asset prices.
Are we in a currency war?
The situation in 2022 is different from that of
2010. In 2022, countries want to curb inflation
but also want to avoid or delay hurting
domestic industries through higher borrowing
costs.
One of the measures used by central banks to
curb inflation is raising interest rates, as it
lowers spending. Just like lowering interest
rates can depreciate a currency, hiking interest
rates can appreciate a currency.
How?
Appreciation of a currency might be favourable
for countries dependent on imports for key
materials like crude oil, which has been quite
volatile over the past few years. However,
rising interest rates would hurt domestic
industries. This can also have an effect on
international capital flows.
Is currency war still going on?
No, currently currency war is not been fought
but in 2022 we came to close to the currency
war when Russia devalued it’s currency due
to which some more countries devalued their
currency after a month everything became
normal and war didn’t happen.
International conditions
required for currency war
For a widespread currency war to occur a
large proportion of significant economies
must wish to devalue their currencies at once.
This has so far only happened during a global
economic downturn.
An individual currency devaluation has to
involve a corresponding rise in value for at
least one other currency. The corresponding
rise will generally be spread across all other
currencies[20] and so unless the devaluing
country has a huge economy and is
substantially devaluing, the offsetting rise for
any individual currency will tend to be small
or even negligible. In normal times other
countries are often content to accept a small
rise in the value of their own currency or at
worst be indifferent to it. However, if much of
the world is suffering from a recession, from
low growth or are pursuing strategies which
depend on a favourable balance of payments,
then nations can begin competing with each
other to devalue. In such conditions, once a
small number of countries begin intervening
this can trigger corresponding interventions
from others as they strive to prevent further
deterioration in their export competitiveness.
The U.S. Strong Dollar Policy
The U.S. has generally pursued a "strong
dollar" policy for many years with varying
degrees of success. The U.S. economy
withstood the effects of a stronger dollar
without too many problems, although one
notable issue is the damage that a strong
dollar causes to the earnings of American
expatriate workers.
However, the U.S. situation is unique. It is the
world's largest economy and the U.S. dollar is
the global reserve currency. The strong dollar
increases the attractiveness of the U.S. as a
destination for foreign direct investment
(FDI) and foreign portfolio investment (FPI) .
Not surprisingly, the U.S. is a premier
destination in both categories. The U.S. is also
less reliant on exports than most other
nations for economic growth because of its
giant consumer market, by far the biggest in
the world.
What Do Countries Try to
Achieve in a Currency War?
A country devalues its currency in order to
decrease its trade deficit. The goods it
exports become cheaper, so sales rise.
The goods it imports become more
expensive, so their sales decline in favor
of domestic products. The end result is a
better trade balance.
The problem is, other nations may
respond by devaluing their own
currencies or imposing tariffs and other
barriers to trade. The advantage is lost.
Quantitative easing
Quantitative easing (QE) is the practice in
which a central bank tries to mitigate a
potential or actual recession by increasing
the money supply for its domestic economy.
This can be done by printing money and
injecting it into the domestic economy
via open market operations. There may be a
promise to destroy any newly created money
once the economy improves in order to avoid
inflation.
Quantitative easing was widely used as a
response to the financial crises that began in
2007, especially by the United States and the
United Kingdom, and, to a lesser extent,
the Eurozone. The Bank of Japan was the first
central bank to claim to have used such a
policy.
Although the U.S. administration has denied
that devaluing their currency was part of their
objectives for implementing quantitative
easing, the practice can act to devalue a
country's currency in two indirect ways.
Firstly, it can encourage speculators to bet
that the currency will decline in value.
Secondly, the large increase in the domestic
money supply will lower domestic interest
rates, often they will become much lower
than interest rates in countries not practising
quantitative easing.
Mechanism for
devaluation
A state wishing to devalue, or at least check
the appreciation of its currency, must work
within the constraints of the
prevailing International monetary system.
During the 1930s, countries had relatively
more direct control over their exchange rates
through the actions of their central banks
Does the Israel-Hamas war
affect currency war?
The conflict between Israel and Hamas is not
affecting India’s trade with Israel
immediately. India’s 1.8% merchandise
exports to Israel are mostly petroleum
products. Israel imports $5.5-6 billion in
refined hydrocarbons from India. India’s
exports to Israel were $8.4 billion in FY-2023.
High crude oil prices hurt India impacting
currency stability making imports expensive,
possibly worsening the government’s fiscal
deficit, widening the CAD further impacting
currency adversely and affecting the profit
margins of sectors such as aviation, paints,
tyres and chemicals.
Does the Russia-Ukraine war
affect currency war?
The war between Russia-Ukraine adversely
affected global currencies. However,
European currencies, particularly the Russian
rouble, Czech koruna and Polish zloty
currencies, depreciated against the USD,
Pacific currencies appreciated significantly.
Due to the financial and economic sanction
imposed on Russia, as well as Poland and the
Czech Republic’s proximity to the war zone,
their currencies have weakened significantly
against the USD. Furthermore, the Russian
Central Bank’s announcement has had a
significant positive impact on pan-American,
European, particularly the Russian rouble and
Polish zloty currencies. These have significant
implications for investors, portfolio managers
and research
Positive effects
1. Increased exports: A weaker currency can
make exports cheaper and more competitive,
leading to increased demand and higher
export revenues.
2. Boost to domestic industries: A weaker
currency can help domestic industries, such
as manufacturing and tourism, by making
their products and services more competitive.
3. Increased economic growth: A currency
war can lead to increased economic growth,
as a weaker currency can stimulate domestic
demand and investment.
Negative effects:
1. Reduced imports: A weaker currency can
make imports more expensive, leading to
reduced demand and higher prices for
consumers.
2. Inflation: A currency war can lead to
inflation, as a weaker currency can increase
the price of imported goods and services.
3. Reduced purchasing power: A weaker
currency can reduce the purchasing power of
consumers, leading to reduced consumption
and lower living standards.
4. Uncertainty and volatility: Currency wars
can create uncertainty and volatility, leading
to reduced investment and lower economic
growth.
5. Negative impact on trade balances: A
currency war can lead to a deterioration in
trade balances, as a weaker currency can lead
to a surge in imports and a decline in exports.
6. Risk of capital flight: A currency war can
lead to capital flight, as investors seek to
move their assets to safer currencies, leading
to a decline in investment and economic
growth.
7. Reduced international trade: A currency
war can lead to reduced international trade,
as countries may impose trade restrictions
and tariffs to protect their domestic
industries.
It's important to note that the effects of a
currency war on national income can vary
depending on the specific circumstances of a
country, including its economic structure,
trade balances, and monetary policy.
Conclusion
Currency wars are a complex and sensitive
issue, with far-reaching consequences for
international trade and economic stability.
Understanding the causes, effects, and
theories behind currency wars is crucial for
policymakers and economists.
