Currency Wars
PART A-
Meaning & Definition-
A currency war (sometimes called competitive
devaluation) occur when governments intentionally lower
the value of their national currency compared to others.
The goal behind this is to make exports cheaper and more
attractive to foreign buyers, boosting domestic industries
and economic growth.
When one country does it, others often respond by
devaluing their own currencies, leading to a cycle of
competitive devaluations that can destabilize global trade.
Features of Currency Wars
1. Deliberate Currency Manipulation – Countries
purposely weaken their currency to gain a trade
advantage.
2. Export-Oriented Motive – Main aim is to make
exports cheaper and imports costlier.
3. Competitive Nature – One country’s devaluation
triggers others to retaliate, leading to a cycle.
4. Use of Monetary & Policy Tools – Central banks
employ methods like interest rate cuts, quantitative
easing, forex intervention, and capital controls.
5. Global Impact – While giving short-term benefits,
currency wars create inflation, trade disputes, and
global instability.
Source- www. investopedia.com &
A Brief History of Currency Wars-
The idea of manipulating exchange rates for national
advantage is not new, but the phrase “currency war”
became popular in the 1930s during the Great Depression.
Back then, many countries abandoned the gold standard
and tried to devalue their currencies to promote exports
and recover from economic downturns. This led to a series
of competitive devaluations that worsened global economic
conditions and contributed to trade conflicts.
Some important historical moments related to currency
wars:
1930s Great Depression: Countries like the UK and
US devalued currencies after leaving gold standard,
escalating trade tensions worldwide.
Post-World War II Era: The Bretton Woods system
established fixed exchange rates to avoid currency
wars, stabilizing global trade for decades.
1970s Breakdown of Bretton Woods: Floating
exchange rates returned, leading to occasional
competitive devaluations but not full-scale currency
wars.
2010s “Currency War” Talk: After the 2008 financial
crisis, countries like Japan and Brazil accused others,
especially the US, of manipulating currencies through
quantitative easing and monetary easing policies.
This history shows that currency wars usually flare up
during economic crises or when global growth slows,
making them a recurring feature of international finance.
Source- www. fxtribune.com/
PART 2-
Reason for Devaluation-
1. Boost Exports
When a currency is devalued, goods and services exported
by that country become cheaper for foreign buyers. This
tends to increase export volumes.
Cheaper exports can help stimulate domestic production,
employment, and growth in export-industries.
On the other hand, a more valuable currency
makes exports relatively more expensive for purchase in
foreign markets.
2. Shrink Trade Deficits
If a country is importing much more than exporting, there
is a net outflow of foreign currency or reserves.
Devaluation makes imports more expensive and exports
cheaper, which can reduce the deficit.
This favours an improved balance of payments as exports
increase and imports decrease, shrinking trade deficits.
3. 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 is in the domestic
currency and payments are fixed nominally, devaluation
can reduce the real cost of those payments.
PART C-
Mechanism of Currency Wars-
Quantitative easing (QE)
Quantitative Easing (QE) is a monetary policy tool used
by central banks when normal methods, like changing
interest rates, are not enough to boost the economy.
Under QE, the central bank creates new money
electronically and uses it to buy government bonds or
other financial assets from banks and financial
institutions.
This increases the money supply in the economy,
lowers long-term interest rates, and encourages
borrowing, investment, and spending.
Lowering interest rates
Lowering interest rates is one of the most common tools
used by central banks to influence the economy and the
value of their currency. When the central bank reduces its
policy interest rate (like the repo rate in India), it makes
borrowing cheaper and reduces the returns on savings.
This policy stimulates domestic demand and also weakens
the currency, because investors look for higher returns
elsewhere and move their money out of the country.
Intervention buying
Foreign Exchange (Forex) intervention means that a
country’s central bank directly buys or sells
currencies in the forex market to influence the exchange
rate of its own currency. This is one of the most direct
mechanisms used in a currency war.
The bank either-
1. Weakens Domestic Currency (Promote Exports):
Central bank sells its own currency in large
amounts and buys foreign currency (like U.S.
dollars) due to which the domestic currency
supply increases & its value falls.
2. Strengthen Domestic Currency (Control Inflation):
Central bank buys its own currency using
foreign exchange reserves. This reduces the
supply of local currency its value rises due to
which imports become cheaper, helping control
inflation.
Controlling capital flows
Capital flows refer to the movement of money for
investment, trade, or business between countries.
When foreign investors pour money into a country, its
currency tends to appreciate (become stronger).
Similarly, when capital leaves, the currency depreciates
(becomes weaker).
1. Restrictions on Inflows- When too much foreign
investment enters, the domestic currency may
become too strong. To prevent this, countries may tax
foreign investments, set limits, or require minimum
holding periods.
2. Restrictions on Outflows- During crises, sudden
withdrawal of capital can sharply weaken the currency.
Governments may limit how much money residents
can send abroad or cap withdrawals to stabilize the
currency.
