Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

What You Need To Know: Currency Wars

By

For an economy on the fritz, devaluing your currency can offer a way to increase your exports and jumpstart growth. But what happens when everyone does it?

PrintPRINT
When a country's economy is on the fritz, the devaluation of its currency can be a godsend. Currency devaluation sounds negative and, in fact, it is for domestic users of the currency -- if the exchange rate with other countries rises, both foreign goods and domestic goods manufactured abroad become increasingly expensive. A weak exchange rate is an especially grave problem in countries that rely on imported goods.

Why Countries Want Their Money to Lose Value
In a developing country, however, where consumerism is at subsistence level and travel nil, devalued currency has a strong upside -- the country can reap a sizeable profit from exporting its goods to a country whose stable currency is valued much higher than its own.

In a developed country, depreciating currency makes the country more attractive to buyers not only of goods but of currency itself, including debt.

When times are good, this arrangement works out well for nearly everyone. The exporting country sells its goods for a higher price than it could at home, with the added benefit of collecting strong currency that it can exchange at a premium back home.

The importing country benefits from the advantageous exchange rate and gets to buy goods cheaper than it could domestically.

The losers in this scenario are the domestic producers in the strong-currencied country, who find it difficult to compete with the imports. In the US, domestic producers can turn to the US Department of Commerce's International Trade Administration for help. If it determines a country's exports are hurting a domestic industry, the ITA imposes countervailing tariffs to level the field or recoup lost profits.

So What's the Problem?

What's brought on the current so-called currency wars is that since the economic crisis, no one country is in a sturdy enough position to be the strong currency leader. The currency wars are thus the equivalent of an international monetary race to the bottom. Each country looks for ways to devalue its own currency while strongly denouncing such efforts by other countries.

For the US, the go-to culprits in the currency wars are Japan and China, which not-so-coincidentally, also happen to be the two biggest foreign buyers of US Treasury securities -- as of November 2010, China was holding $895.6 billion; Japan, 877 billion.

Although it may seem logical that these countries would hail the devaluation of the dollar -- the less the dollar is worth, the more securities China and Japan can buy -- in fact the devaluation operates at cross purposes with the whole point of buying the securities, which is to be vested in a liquid yet undeniably secure venture.

China has the further incentive of keeping its economy stable to avoid the kind of domestic social unrest that could subvert its attempts to become a world economic force.

Despite its helpful gobbling up of T-bills, China remains a particular target for the US because, unlike most other players who at least pretend to determine the value of their currency based on the flux of the free market, the Chinese government decides what value renminbi has.

The (Unintended?) Effect of Quantitative Easing
The ostensible Bernanke/Geithner justification for quantitative easing (QE) -- otherwise known as printing money to make it easier for banks to lend it -- was to prevent deflation by raising inflation. Some scratched their heads at this, wondering by what measure deflation in any US sector was a remote possibility. Many have speculated however, that the major unspoken reason for QE is in fact currency devaluation, which can't be said publicly for political reasons, such as being seen to start a currency war...

As it turns out, QE2 has had a drastic impact, not directly on the domestic economy, but on the global one. Rather than pouring into the US economy, the money freed up from QE2 poured into, among other countries, China -- at the rate of $1 billion per day by some estimates.

To maintain its artificially low exchange rate with the dollar, China had to print money, too. Printing money had the effect there that was expected here -- massive inflation. Inflation isn't great for the citizens of any country, but for China, it's a grim reminder of periods of social unrest that began with a destabilized economy. With yuan flooding the market, China is now forced into the position of either raising the value of renminbi -- amid constant US pressure to do so -- or regressing from its current trade position.

Global Currency Markets
It isn't just renminbi that's taking a hit from QE2. Japan, South Korea, Thailand, Taiwan, Brazil and nearly 40 other countries are feeling the pinch of the depreciating dollar and the flood of it coming into their respective countries. Brazil, in particular, has felt the sting -- the Brazilian real rose 35% against the dollar in 2010.

Many are responding by instituting internal capital controls, including taxing foreign bond buyers. Some are mulling having their central banks stop using the international dollar as an economic fixed point and moving instead to gold, oil or a money mix -- a kind of global-currency mutual fund that would theoretically act as a buffer against dramatic shifts in the value of any one currency. The obvious problem with this theory -- as with the flawed premise that led to the mortgage meltdown -- is that currencies can and do fall together.

The G-20 summit, where currency wars were the central issue, brought no solutions. It did bring speculation that the global dollar would soon be abandoned in favor of something more stable and less subject to tinkering -- though what that something might be has so far remained ephemeral.

Why Call It Currency Wars?
The name comes from the 2007 Song Hongbing book, The Currency War, sometimes translated as "Currency Wars," a best-seller in China. The book posits that US wealth is situated in a few hands. The economy is run by a group of private banks, including the Federal Reserve, that loan money in global dollars to developing nations and then manipulate the currency market to their own advantage. The book's upshot is that China should distance itself from the US if it wants to become a world power. Chinese leaders reportedly read the book the way Wall Street-ers read Sun Tzu's Art of War.

Too Long, Didn't Read? The Key Takeaways:

  • In a developed country, depreciating currency makes the country more attractive to buyers not only of goods but of currency itself, including debt.
  • What's brought on the current so-called currency wars is that since the economic crisis no one country is in a sturdy enough position to be the strong currency leader.
  • With yuans flooding the market, China is now forced into the position of either raising the value of renminbi or regressing from its current trade position.
  • Some are mulling having their central banks stop using the international dollar as an economic fixed point and moving instead to gold, oil or a money mix
< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

PrintPRINT
 
Featured Videos

WHAT'S POPULAR IN THE VILLE