INDEX

1. Why I selected this topic – 1

2. What is a currency war – 1

3. Understanding currency wars – 2

4. Comparison between 19th and 21st century - 1

5. Reasons for currency war - 1

6. Currency war or competitive devaluation – 1

7. Why depreciate a currency – 1

8. Exchange rate systems - 1

9. The U.S strong dollar policy - 1

10. The U.S dollar’s surge – 1

11. The pre-covid situation – 1

12. Policy divergence - 1

13. Negative Effects of currency war – 1

14. Does Currency affect trade wars – 1

15. What do countries try to achieve in a currency war

–1
16. Is India in a currency war? – 1

17. Case study – 1

18. Conclusion – 1

19. Bibliography - 1
Reason for selection

Currency war is a very relevant and engaging topic for

research in today’s world. This is due to several reasons,
some of which are given below:
Economic Relevance: Currency wars can significantly
impact global economies, affecting trade balances,
inflation rates, and economic growth.
Market Volatility: Fluctuations in currency values can lead
to market instability, impacting investments and financial
markets.
Technological Influence: The rise of digital currencies
and fintech is changing how currency wars are fought.
Public Awareness: Many people are unaware of how
currency issues affect their daily lives.

All these factors make it a vital topic for understanding

global power dynamics.
What is a currency war?
A currency war is an escalation of currency devaluation
policies among two or more nations, each of which is
trying to stimulate its own economy. Currency prices
fluctuate constantly in the foreign exchange market.
However, a currency war is marked by a number of
nations simultaneously engaged in policy decisions aimed
at devaluing their own currencies.

Nations devalue their currencies primarily to make their

own exports more attractive on the world market.

They highlight the complexities of global trade and

monetary policy, often resulting in economic and political
tensions among nations.
Understanding currency war
In a currency war, nations devalue their currencies in order
to make their own exports more attractive in markets
abroad. By effectively lowering the cost of their exports,
the country's products become more appealing to
overseas buyers. This is sometimes referred to as
competitive devaluation.

At the same time, such devaluation makes imports more

expensive to the nation's own consumers, forcing them to
choose home-grown substitutes.

This combination of export-led growth and increased

domestic demand usually contributes to higher
employment and faster economic growth.

However, it may also lower a nation's productivity. The

nation's businesses may rely on imported equipment and
machinery to expand their production. If their own
currency is devalued, those imports may become
prohibitively expensive.

Economists view currency wars as harmful to the global

economy because these back-and-forth actions by nations
seeking a competitive advantage could have unforeseen
adverse consequences, such as increased protectionism
and trade barriers.

The implications extend beyond economics; currency wars

can strain diplomatic relations, as nations view each
other’s devaluation tactics as aggressive or unfair.
Historical examples, such as the Great Depression in the
1930s, illustrate how competitive devaluations can
heighten economic challenges and lead to broader
protectionist measures.
In the modern context, the rise of digital currencies and
international trade agreements complicates the dynamics
of currency wars. Policymakers must navigate the delicate
balance between stimulating growth and maintaining
healthy international relations, making understanding
currency wars essential for comprehending today’s global
economy.
Comparison between the 19th and 21st
century

Aspect 19th century 21st century

Context Primarily during Globalization and
the Gold floating exchange
Standard era. rates.
Methods Silver and gold Quantitative
standard easing, interest
manipulation, rate adjustments,
tariffs. direct currency
intervention.
Key Players Major European Major economies
powers (e.g., UK, (e.g., US, China,
France, Eurozone).
Germany).
Global Impact Limited to direct Widespread
trade effects on global
relationships. financial markets.
Technological Limited Digital currencies
Influence communication and real-time
and trade trading platforms.
technology.
Public Awareness Mostly elite and Increased public
government and media
focus. engagement.
Reasons for currency war
Several factors can contribute to the emergence of
currency wars:

● Economic Competitiveness - Countries might engage

in currency wars to boost their export
competitiveness.
● Trade Imbalances - Persistent trade imbalances,
where one country consistently runs a large trade
surplus while another runs a deficit, can trigger
currency wars.
● Monetary Policy Divergence - Differences in monetary
policies among countries can lead to currency wars.
● Geopolitical Tensions - Currency wars can also be
influenced by geopolitical factors.
● Domestic Political Considerations - In some cases,
policymakers may devalue their currency to appease
domestic industries or interest groups that depend
heavily on exports.
● Deflationary Pressures - When an economy faces
deflationary pressures, a depreciating currency can
help stimulate inflation and boost economic activity.

International organizations such as The International

Monetary Fund (IMF) and The World Trade Organization
(WTO) closely monitor currency policies to prevent
excessive manipulation and maintain a stable global
economic environment.
Currency War or Competitive Devaluation

Currency war refers to a situation where countries engage

in competitive devaluations to gain an economic
advantage, typically by lowering their currency's value to
boost exports. It can involve multiple nations adopting
similar policies, leading to a cycle of devaluation. This can
create tension in international relations and disrupt global
trade.

Competitive Devaluation is a more specific action taken by

a country to intentionally lower the value of its currency.
This can be done through monetary policy measures, such
as lowering interest rates or directly intervening in the
foreign exchange market.

In essence, while competitive devaluation refers to the act

of lowering a currency's value, a currency war describes
the larger context of countries engaging in such practices
simultaneously. Both can have significant implications for
global trade and economic stability.
Why depreciate a Currency?
It may seem counter-intuitive, but a strong currency is not
necessarily in a nation's best interests.
A weak domestic currency makes a nation's exports more
competitive in global markets while simultaneously making
imports more expensive. Higher export volumes spur
economic growth, while pricey imports have a similar
effect because consumers opt for local alternatives to
imported products.

This improvement in the terms of trade generally

translates into a lower current account deficit (or a greater
current account surplus), higher employment, and faster
growth in gross domestic product (GDP).

The stimulative monetary policies that usually result in a

weak currency also have a positive impact on the nation's
capital and housing markets, which in turn boosts
domestic consumption through the wealth effect.

Beggar thy neighbor

Since it is not too difficult to pursue growth through
currency depreciation—whether overt or covert—it should
come as no surprise that if nation A devalues its currency,
nation B will soon follow suit, followed by nation C, and so
on. This is the essence of competitive devaluation. The
phenomenon is also known as "beggar thy neighbor”.

Exchange rate systems

Exchange rate systems determine how a country's
currency value is set relative to others. In a currency war,
nations may devalue their currencies intentionally to boost
exports and gain competitive advantages. This often leads
to retaliatory actions from other countries, creating a cycle
of devaluation that can destabilize global trade.

Fixed exchange rate systems - Fixed exchange rate

systems limit currency fluctuations, reducing the scope for
competitive devaluation. However, they can lead to
tensions if countries perceive manipulation, potentially
escalating conflicts in currency wars.

Floating exchange rate systems - Floating exchange rate

systems allow greater flexibility, enabling countries to
adjust currencies easily, potentially leading to competitive
devaluations and currency wars.

Pegged exchange rate systems - Pegged exchange rate

systems maintain stable currency values, reducing
competitive devaluation risks, but can cause tensions if
adjustments are perceived as manipulation.
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.
The U.S Dollar’s Surge
When Brazilian minister Mantega warned back in
September 2010 about a currency war, he was referring to
the growing turmoil in foreign exchange markets, sparked
by new strategies adopted by several nations. The U.S.
Federal Reserve's quantitative easing program was
weakening the dollar, China was continuing to suppress
the value of the yuan, and a number of Asian central
banks had intervened to prevent their currencies from
appreciating.

Ironically, the U.S. dollar continued to appreciate against

almost all major currencies from then until early 2020, with
the trade-weighted dollar index trading at its highest levels
in more than a decade.

Then, in early 2020, the coronavirus pandemic struck. The

U.S. dollar fell from its heady heights and remained lower.
That was just one side effect of the coronavirus pandemic
and the Fed's actions to increase the money supply in
response to it.
The Pre-covid Situation

The dollar surged in the years before the COVID-19

pandemic primarily because the U.S. was the first major
nation to unwind its monetary stimulus program, after
being the first one out of the gate to introduce Quantitative
Easing.

The long lead-time enabled the U.S. economy to respond

positively to the Federal Reserve's successive rounds of
QE programs.

The U.S.-China trade tensions, European monetary

easing, and Japan's loose monetary policies fueled
competition. Countries aimed to boost exports and counter
slow growth, but this raised fears of destabilizing global
trade and financial markets.

Canada, Australia, and India, which had raised interest

rates soon after the end of the Great Recession of
2007-09, had to subsequently ease its monetary policy
because growth momentum slowed.
Policy Divergence
While the U.S. implemented its strong dollar policy, the
rest of the world largely pursued easier monetary policies.
This divergence in monetary policy is the major reason
why the dollar continued to appreciate across the board.

The situation was worsened by a number of factors:

● Economic growth in most regions was below historical

norms and many experts attributed this sub-par
growth to fallout from the Great Recession.
● Most nations exhausted all other options to stimulate
growth, with interest rates at historic lows. With no
further rate cuts possible and fiscal stimulus not a
controversial option, currency depreciation was the
only tool remaining to boost economic growth.
● Sovereign bond yields for short-term to medium-term
maturities had turned negative for a number of
nations. In this extremely low-yield environment, U.S.
Treasuries attracted a great deal of interest, leading to
more dollar demand.
Negative Effects of Currency War
Currency devaluation may lower productivity in the long
term since imports of capital equipment and machinery
become too expensive for local businesses. If currency
depreciation is not accompanied by genuine structural
reforms, productivity will eventually suffer.

The effects include:

● The degree of currency depreciation may be greater

than what is desired, which may cause rising inflation
and capital outflows.
● Devaluation may lead to demands for greater
protectionism and the erection of trade barriers, which
would impede global trade.
● Devaluation can increase the currency's volatility in
the markets, which in turn leads to higher hedging
costs for companies and even a decline in foreign
investment.
Does Currency Affect Trade wars?
It may be the reverse: A trade war damages the currency
of the country it targets.

In trade wars, countries often impose tariffs or trade

barriers to protect their domestic industries. A weaker
currency can offset the impact of tariffs by making exports
even cheaper, which may prompt retaliatory measures.
This creates a feedback loop, where trade policies and
currency devaluations interact, intensifying the conflict.

Example:
The United States has an enormous trade gap with China.
In January 2024, the U.S. imported more than $35 billion
worth of goods from China and exported nearly $12 billion.

In 2020, then-President Donald Trump tried to adjust that

imbalance by imposing a raft of tariffs on Chinese goods
entering the U.S. This protectionist policy was aimed at
increasing the prices of Chinese goods and therefore
making them less attractive to U.S. buyers.

One effect was an apparent shift in U.S. manufacturing

orders from China to other Asian nations such as Vietnam.
Another effect was a weakening of the Chinese currency,
the Renminbi. Less demand for Chinese products led to
less demand for the Chinese currency.

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.
Is India in a Currency War?
India is not currently in an active currency war, but it faces
currency-related challenges within the global economic
environment.

India's currency, the rupee, has been influenced by

external factors like the U.S. dollar's strength, global
economic conditions, inflation, and oil prices.
India's central bank, the Reserve Bank of India (RBI),
closely manages the rupee's value to prevent excessive
depreciation or volatility, which could impact inflation and
the cost of imports, especially energy. Rather than
engaging in competitive devaluation, the RBI often
intervenes to stabilize the rupee when necessary.
India's trade policies focus on improving its export
competitiveness through structural reforms and boosting
manufacturing, rather than manipulating its currency.
However, global currency fluctuations, including a strong
U.S. dollar, can affect India's trade dynamics and financial
markets.
Case Study
1) The Great Depression is the canonical case of a
widespread currency war, with more than 70 countries
devaluing between 1929 and 1936. Existing
scholarship, however, has largely focused on the
beggar-thy-neighbor effects of devaluations rather
than their collective effect on the disintegration of the
interwar gold standard. Harvard uses newly-compiled,
high-frequency bilateral trade data and gravity models
that account for when and whether trade partners had
devalued to identify the effects of the currency war on
global trade. Their empirical estimates show that a
country’s trade was reduced by more than 21%
following devaluation relative to its trade partners that
had yet to devalue. This negative and statistically
significant decline in trade suggests that the currency
war destroyed the trade-enhancing benefits of the
global monetary standard, ending regime coordination
and increasing trade frictions.
2) In February 2013, the G-20 finance ministers met in
Moscow, Russia to discuss the rising anxieties over a
potential international currency war. It was speculated
that certain countries were purposely devaluing their
currencies in order to improve their competitiveness in
global markets. Emerging markets contended that the
expansionary monetary policies of the major central
banks, such as the US Federal Reserve, European
Central Bank, and the Bank of England, were causing
significant and detrimental spillover effects, such as
currency appreciation, declining exports, and rising
inflation, in less developed economies. Conversely,
the major central banks insisted that such policies
were necessary for reviving economic growth both
domestically and internationally.
Conclusion
A currency war takes place when two or more countries
engage in practices that devalue their own currencies, in
an attempt to stimulate demand for their products. Such
devaluations also have the effect of increasing the cost of
imports, which can spur consumers to buy domestic goods
instead. Combined, this can spur employment and growth,
but it also risks inflation and capital outflows. If currency
depreciation policies are not accompanied by other
economic reforms, eventually its advantages will be lost as
other countries take the same actions.