Currency War

What is meant by currency war?

The term ‘currency war’ was used in recent times by Brazil’s finance minister Guido Mantega in the first week of October this year reacting to China’s attempt to protect the yuan from rising too quickly against the dollar. It comprises competitive measures by governments to improve their trade by maneuvering exchange rates. A cheap currency, vis-àvis the dollar, adds to the competitive advantage to the exporter. Countries such as China, Brazil, South Korea and Japan have taken measures to devaluate their currencies which would help them boost exports and create jobs. An attempt by the government to prevent its currency from appreciating too steeply and too fast against competing nation is what is seen as currency war between different countries . The history of currency wars dates back to the Great Depression era when major economies devalued their currencies as a part of a measure to give preference to local goods over imported ones.

What is its impact on Indian economy?

When competitors devalue their respective currencies, domestic exporters tend to lose out on the price advantage on their exportables as buyers prefer to buy from a cheaper currency. This in turn hurts income as well as the jobs in the export sector and the prospects for the economy. The central bank at such times tries to intervene — buy dollars and create an artificial demand for the dollar, devaluing the value of the rupee in the process and retain some price advantage for the exporter . But buying dollars involves a fiscal cost as the central bank has to pump in equivalent amount of rupees and again mop it up by selling bonds. These bonds need to be serviced by the government. This would in turn worsen the fiscal position .

How does currency war impact global recovery?

Currency wars are a part of what is described as a ‘beggar thy neighbour’ policy — attempts by a country to solve its economic problems by causing worse difficulties in other markets. When all countries engage in such policies, it turns out to be a race to the bottom. As countries compete to devalue their currencies to save the interest of their exporters, it collectively reduces demand for foreign goods, something that world economies cannot afford at a time when the process of global recovery from the after affects of the crisis of 2008-09 is still underway. Also , competitive currency devaluation is happening at a time, when some of the developed economies have a soft money situation, wherein monetary regulators are on a quantitative easing spree, lowering their interest rates, which is making emerging economies trying to regulate their inflation an arduous task, as direction of the capital flows has turned towards them. There is also the fear of a bubble, which will burst once developed economies are back on track and the flow of capital shrinks. This shrinking is expected to be first reflected in the currency markets.

What is the current international thinking on the matter?

The United States is looking for global support at forums such as the G20 to the IMF, so that there can be collective pressure on China to ease up on the Yuan. IMF feels that it is the right place to make progress on the currency question . Emerging nations are not very keen to range themselves in this battle. Finance minister Pranab Mukherjee has said he urged countries to work towards a consensus as the way forward.

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Threat of Currency War:

It may not really be a currency war, but even I was surprised by the aggressive language being used by senior American and Chinese officials in Washington last week. Not to mention the head of the IMF. It's been a long time since economic relations between the major powers have been this bad-tempered.

I reported from the "frontline" last Thursday, but here's an "idiot's guide" to the debate over global currencies, which I've just done for the World Service.

Coming out of the financial crisis, every country wants to grow as fast it can. That's not the problem. The problem is how.

The United States and Britain have the largest budget deficits in the G20 - which means they're looking at years of cuts. They're looking for exports to pick up the slack, and the best way to boost exports is through a weaker currency.

The problem is that the eurozone wants the same thing. So does Japan. And so does China - even though America and the eurozone think it's time that the Chinese consumer stepped up to the plate.

It sounds like a global price war, with each country fighting to under-bid the other. But when companies have price wars - don't we consumers usually win?

The trouble is that exchange rates aren't the same as prices - if the dollar is going down, then other currencies have to go up. And governments aren't companies: if they don't like where their currency is going they can intervene. The rest of the world is left fighting the price war on its own.

That is exactly what China and other Asian exporting countries have been doing for the last few years - they've spent hundreds of billions of dollars fixing the market to keep their exports cheap. More than a trillion, in the case of China, which now sits on a mountain of dollar reserves.

At the start of the summer, China promised to let its exchange rate go up - but since then it has strengthened against the dollar by just 2%. The yuan has fallen about 10% against the euro and the yen. You can see why the US and other governments gathered in Washington last week were less than thrilled.

China says the focus on the exchange rate misses the point - policy-makers should focus on the why the US saves too little as a nation, and Asian economies save too much. Long term, that IS what re-balancing the global economy must be about.

But, as the director of the International Monetary Fund said last week, you can't go many steps along that road without a substantial change in exchange rates.

That's why you should worry about where talk of currency wars will lead. Because if the world's leaders cannot agree on the role that currencies will play in this global economy - they're not going to agree on very much else.