The foreign exchange market experiences continuous fluctuations in currency prices. Nonetheless, a currency war is characterized by multiple countries making policy measures at the same time with the intention of depreciating their own currencies. Countries mostly devalue their currencies to increase the appeal of their own exports on the global market. Countries depreciate their currencies in a currency war to increase the appeal of their exports in foreign markets. Products from the nation are more enticing to purchasers abroad when the cost of exporting is successfully reduced. This is known as competitive devaluation at times.
But it might potentially reduce a country’s output. Businesses in the country might depend on machinery and equipment imports to increase output. Should their own currency depreciate, the cost of those imports might become unaffordable.
Because these back-and-forth moves by countries looking for a competitive advantage could have unanticipated negative effects, such greater protectionism and trade barriers, economists consider currency wars as detrimental to the world economy. With floating exchange rates in place today, market forces mostly decide the value of currencies. Nonetheless, the central bank of a country can manipulate currency depreciation by implementing economic measures that lower the value of the currency.
One strategy would be to lower interest rates. Another is known as quantitative easing (QE), wherein a central bank purchases bonds or other assets on the market in bulk. Although the methods used here are less obvious than currency devaluation, the results might be the same.
Compared to the currency wars of decades past, when fixed exchange rates were common and a country could weaken its currency by simply reducing the “peg” to which its currency was fixed, the combination of private and public measures creates greater complexity. The phrase “currency war” is not used lightly in the ivory towers of economics and central banking, which is why former Brazilian Finance Minister Guido Mantega created a sensation when he declared that a global currency war had broken out in September 2010. A CNBC article claimed that the European Union, the Bank of England, and the United States central banks were involved in a “covert currency war” in 2019. With interest rates at an all-time low, the central banks’ sole remaining tool for boosting their economies was currency devaluation. China devalued its currency in relation to the dollar peg and retaliated with tariffs of its own in the same year that the Trump administration placed tariffs on Chinese goods. That might have turned a conflict about commerce into one over money. A country’s exports become more competitive in international markets as its domestic currency depreciates, but imports become more costly. Economic growth is stimulated by higher export volumes, but expensive imports also have this effect since consumers choose to purchase local goods instead of imported ones.
An improvement in terms of trade typically results in increased employment, a faster growth rate of the gross domestic product (GDP), and a smaller current account deficit (or surplus).
The industrial and service sectors’ current economic trends are indicated by the purchasing managers index. The nonprofit Institute for Supply Management (ISM) is responsible for compiling and disseminating the indicator on a monthly basis.
The nation’s capital and property markets benefit from the stimulative monetary policies that typically result in a weak currency, and this, in turn, increases domestic consumption through the wealth effect. Currency depreciation, whether overt or covert, is a relatively easy way to seek growth. Therefore, if nation A devalues its currency, nation B will probably follow suit shortly after, followed by nation C, and so on. This is what competitive devaluation is all about.
Another term for the situation is “beggar thy neighbor,” which refers to a national monetary policy of competitive devaluation that is undertaken to the detriment of other countries rather than a Shakespearean epithet. Depreciation of currency is not a cure-all for all economic issues. Brazil serves as an example. The nation’s attempts to devalue the Brazilian real in an attempt to ward off its economic woes led to hyperinflation and the collapse of the domestic economy.
What then are a currency war’s drawbacks? Long-term productivity loss may result from currency devaluation when imports of machinery and capital equipment become unaffordable for local companies. Productivity will eventually decline if real structural reforms are not implemented in tandem with currency depreciation. Inflation brought on by a currency devaluation, whether intentional or not, can harm a country’s economy. Consumers in the nation will be forced to pay for more expensive goods if imports become more expensive and the country is unable to substitute those imports with locally sourced goods.
When other nations react to a currency devaluation with protectionist measures that have a comparable impact on prices or with their own devaluations, the devaluation turns into a currency war. Each participating nation may be making their trade imbalances worse rather than better by driving up import prices. Alternatively, a trade war may have the opposite effect, weakening the target nation’s currency.
There is a massive trade deficit between the US and China. China was the source of more than $35 billion in U.S. imports and roughly $12 billion in exports in January 2024.
