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Satyajit Das: Why the Currency Wars Matter


Just part of the larger economic conflict between nations, currency wars have significant costs.

In 2012, the Swiss National Bank (OTCMKTS:SWZNF) was forced to build record foreign exchange reserves to maintain the euro at Swiss Franc 1.20 in an effort to shield Switzerland from an economic downturn, driven in part by an appreciating currency. Its reserves of over Swiss Franc 427 billion ($453 billion) are over 75% of Switzerland's annual gross domestic product. The SNB purchased Swiss Franc 188 billion francs ($199 billion) in foreign currencies in 2012, more than 10 times the Swiss Franc 17.8 billion ($18.9 billion) it spent in 2011. The SNB's intervention resulted in losses totaling Swiss Franc 27 billion in 2010.

In Australia, where a rising currency is creating economic problems, policy makers have tacitly acknowledged their powerlessness.

Recent disclosures from the Reserve Bank of Australia show that on their foreign currency holdings, a 10% appreciation in the Australian dollar results in an unrealized loss of about $3.43 billion. Similarly, an increase in interest rates of 1% would result in a valuation loss of $0.66 billion on these securities. Intervention to bring down the value of the Australian would require the RBA to sell the Australian dollar and use the proceeds to buy and hold additional foreign currency securities, increasing these risks.

This restricts the policy options available to smaller economies, limiting their capacity to influence exchange rates and economic activity in practice. Responding to a question about New Zealand's approach, Finance Minister Bill English stated the obvious with disarming honesty: "To influence the exchange rate you need a couple of hundred billion US in the bank so they take you seriously. We'd be out in the war zone with a peashooter."

Enriching Thy Neighbor?

The US and Japan defend their actions, claiming that they are not seeking to devalue their currencies but only trying to boost their domestic economy. In a recent speech, Federal Reserve Chairman Ben S. Bernanke refused to countenance that the US was involved in "beggar-thy-neighbor" policies, arguing that America had adopted an "enrich-thy-neighbor" strategy. He did not elaborate on how this would work, beyond the homily that a strong US economy was good for the world.

Speaking on April 10, 2013, Australia Treasurer Wayne Swan expressed support for American and Japanese reflation policy via QE and currency devaluation. He stated puzzlingly: "Expansionary monetary policy can bring about a depreciation of the currency, but that doesn't mean it is manipulation." He was effusive in his praise of the action of the US: "Thank god for the Fed." Given the effects of the high Australian dollar on Australia's export and competitiveness, the Treasurer's position is curious, especially given increasing American and European disquiet at Japanese actions to weaken the yen.

Ultimately, a policy of devaluation to attain prosperity is flawed, especially when all major nations implement similar policies. Everybody cannot, by definition, have the cheapest currency. In the words of one central bank official, it is like peeing in bed to keep warm; while it might feel good at first, it soon becomes messy and difficult to clean up.

But to expect nations not to use fiscal and monetary policy to manipulate currencies is disingenuous. Circumstances now dictate the use of every available policy tool to serve individual national interests.
No positions in stocks mentioned.

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