Remember the currency war? Brazilian finance minister Guido Mantega had brought this term into common usage when he warned in September 2010 that countries are headed into a race to devalue their currencies in order to protect their export competitiveness. In other words, they were trying to export their way out of trouble.
This war never materialized in the past two years, or at least not as sharply as many had expected. However, the dramatic announcement by the Swiss National Bank on Tuesday is a hint that countries are still keen to manage their currencies in these turbulent times. The Swiss franc has been one of the few safe havens that investors have sought in the midst of the recent problems in the global financial markets. The relentless buying of Swiss francs has sent its value up by a fifth since January, potentially harming the ability of Swiss companies to compete.
The Swiss National Bank has now said it will keep the currency below 1.20 to a euro with “utmost determination” by buying “unlimited quantities” of foreign currencies to keep the Swiss franc below its target level. The Economist’s Buttonwood blog quoted Chris Turner, head of FX strategy at ING, as saying: “This marks a major new round in the currency war. Could not Japan also set a minimum USD/JPY exchange rate at 75 as a means to battle deflation?”
So, currency war redux? In Mumbai, Reserve Bank of India deputy governor Subir Gokarn said on Wednesday: ‘‘The underlining view is that this is a transitory phase and this is not in any way an abandonment of their fundamentally floating exchange rate system. It is an attempt to deal with temporary factors.” In the past two years, the Indian central bank has been one of the few in the world to stay clear of any major interventions to defend or target a particular exchange-rate target. It has only intervened when there is too much volatility in the foreign exchange market.
The Swiss move shows that there are costs on the domestic economy when a currency is seen as a safe haven against financial turbulence. The Swiss have perhaps set off a new sort of currency war, against very rapid appreciation of their currency.
Anyway, a total currency war is logically impossible. Exchange rates are relative prices; all currencies cannot fall against each other. There has to be at least one anchor currency. The US dollar was that currency ever since the gold standard -- an admittedly flawed and rigid monetary system -- was junked after the end of World War 2. There is nothing to replace dollar supremacy right now. Any surprises then that the price of gold has been soaring upwards with the wind?