Currency War Phrase Actually Refers To Problems Of Global Economy Where Countries Are Highly Connected Yet Very Different

Friday, February 22, 2013 07:28
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Currency War Phrase Actually Refers To Problems Of Global Economy Where Countries Are Highly Connected Yet Very Different

Tags: currency | U.S. economy | world economy

Some of the biggest global banter is the threat of a currency war. Rather than a real threat, the phrase is being misused as the moniker for a debate on how developed countries will grow out of their economic malaise.
 
The phrase “currency war” was uttered first by Brazil’s finance minister, Guido Mangega, in 2010.
 
He was referring to the huge effort by the US to keep interest rates low through quantitative easing.

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The Fed’s easy monetary policy resulted in downward pressure on the dollar that pushed the values of other countries’ currencies up.
 
Noting the lesson that physics teaches us—every action has an equal and opposite reaction—the actions of the US Fed have pushed hot money with higher interest rates into primarily emerging countries.
 
This promotes asset price bubbles and incites inflation. The normal reaction of any country on the receiving end would be to ease its own monetary policy and also lower interest to push down the value of its currency.
 
Brazil cannot do this as effectively because it has a very stubborn inflation rate of 6% that doesn’t allow the country to respond as the US can.
 
Rather than a currency war, the reality is that other countries are responding to their own economic troubles by easing their monetary policies.
 
The caveat is that emerging countries’ efforts are not as effective as those of the US because of economic or political issues.
 
The currency war phrase has been resurrected because of the significant drop in the value of the Japanese yen.
 
Japanese exports have become suddenly much cheaper as a result. This makes other countries’ goods much less competitive in the marketplace.
 
The real issue is how emerging countries will respond. The simplest way would be for them to allow their currencies to appreciate.
 
Developed countries like the US and Japan would benefit from having a cheaper currency and more growth and emerging countries would benefit from a stronger currency and greater buying power.
 
So, the so-called currency war really reflects disagreements between countries on how to respond to the easy-money policies of the larger developed nations.

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