What is a currency war and are we heading for one?
- 15 February 2013
- From the section Business
The value of a currency can make or break a country's economy.
If it is too high, it makes the country's exports less competitive. It is is too low, it makes imports too expensive and can trigger high rates of inflation.
At the same time, sharp movements in a currency's valuation often trigger money market fears. The latest have been sparked by a big decline in the yen's value over the past months.
Meanwhile, the euro has risen against a basket of currencies, prompting senior leaders from the region to voice their concerns.
It is little surprise then, that as the finance ministers of the world's 20 biggest economies meet in Moscow, a discussion about currency valuations is expected to be high on the agenda.
Ahead of the meeting some have even warned that the threat of a so-called currency war is looming large on the global economy.
So what exactly is a currency war?
It is a term used to describe competitive devaluation of currencies, a scenario where various nations try to devalue their currencies in an attempt to gain an advantage over each other.
Take for example, the Japanese yen's recent dip against the US dollar and the euro.
This is likely to provide a boost to its exporters as it makes Japanese goods cheaper to foreign buyers compared with other nations, if the value of the currency of those nations doesn't change significantly. Such a move may hurt exports from those nations.
Now, if countries that compete with Japan start to actively intervene in the markets and indulge in competitive devaluation of their currencies, then we may see a currency war.
The fear is that such moves to devalue currencies can spread fast as nations try and negate each others' advantage.
When was the last time there was one?
The last time a major currency conflict broke out was in the 1930s.
It happened as most countries abandoned the Gold Standard. The standard fixed the value of a currency to the price of gold and prevented a country from printing too much money.
However, it also denied policymakers any flexibility to deal with shocks to their economies.
As countries gave up the standard one after another, they tried to devalue their currencies.
Many economists describe the moves as the nations trying to export unemployment to other nations or "beggar thy neighbour". The devaluations also led to some countries imposing tariffs on imports as means of protectionism.
Though there have been subsequent instances of interventions in the currency markets by various nations, they haven't been on a massive international scale to be labelled as a currency war.
Does anyone win such a war?
Well, not really. The simple reason is that if everyone is devaluing their currencies at the same time, then they end up negating each others' advantage.
It can also have a counter effect, as a weak currency makes imports much more expensive. At the same time, the fluctuations in exchange rates can also have a negative effect on trade. Perhaps the biggest example of that is the 1930s currency war, which hurt international trade and contributed to the Great Depression.
What has fanned fears of a new war?
The concerns have been triggered in part by the sharp decline in the yen's value and the rise in the euro.
The Japanese currency has dipped nearly 15% against the US dollar since November, while the euro has risen 6% against a basket of currencies in the past six months.
Japanese policymakers have indicated that they will continue to pursue policies that have resulted in the yen's recent weakness.
On the other hand, some eurozone leaders have voiced concerns over the strength of the single currency, saying it was hurting the region's exports.
With both Japan and the eurozone still mired in recession, some fear they may use a weak currency as a tool to try to prop up their exports and boost economic growth.
So are we heading for one?
Actually, we are not. While there has been a sharp decline in the yen's value, analysts say it is a by-product of the monetary stance that Japan's government has taken to stoke inflation and boost its growth.
Also, there is no evidence to suggest that Japan has intervened in the markets to deliberately weaken its currency. Though its leaders have voiced their support for a weak yen, they have not set any price target.
At the same time, there is no indication from any of Japan's competing nations that they are looking to weaken their currencies to negate Japan's advantage.
Meanwhile, some analysts have also argued that aggressive monetary easing by the US and European central banks after the 2008 - 2009 global financial crisis played a big role in weakening their currencies.
As a result, they say, it is unlikely that G20 will target Japan's recent monetary easing.
Their views have also been backed by senior policymakers. "There is no competitive devaluation, there are no currency wars," said Sergie Storchak, Russia's deputy finance minister. "What is happening is market reaction to exclusively internal decision making."
So what is the G20 likely to say?
The G20 has on previous occasions asked its members to refrain from intervening in the currency markets.
It is highly likely that the group will issue a similar communique at the end of the current meeting.
Earlier this week, the G7 group of nations, which includes Japan, issued a statement saying that they will not set targets for exchange rates of their currencies.
On Thursday, Anton Siluanov, finance minister of Russia, the host of the G20 meeting, said it, too, was likely to say something on similar lines. "The language may differ, but the intent will remain the same," he said.