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Fears of a new currency war

If ECB also finds a way of easing and rigging the value of its currency, there will be an all out currency war
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First Published: Tue, Feb 12 2013. 06 56 PM IST
While it is hard to point when and in what shape competitive devaluation will end, it is a lot easier to foretell that the consequences will not be desirable for the global economy at this stage. Photo: AFP
While it is hard to point when and in what shape competitive devaluation will end, it is a lot easier to foretell that the consequences will not be desirable for the global economy at this stage. Photo: AFP
Updated: Wed, Feb 13 2013. 01 47 PM IST
Concerns are mounting in the euro zone as the euro appreciates against currencies of its major trading partners. European Central Bank (ECB) president Mario Draghi, after leaving the benchmark lending rate unchanged at 0.75% on 7 February, noted: “The exchange rate is not a policy target, but it is important for growth and price stability, and we will certainly want to see whether the appreciation is sustained and will alter our risk assessment as far as price stability is concerned.” Earlier in the week, French President Francois Hollande demanded that the euro zone develop an exchange rate policy or face the risk of having the rate imposed on it by others. Clearly, policymakers are worried that the painful adjustments currently under way in many countries of the single currency zone will get undermined because of a stronger than warranted euro.
The comment from Hollande came just weeks after the Bank of Japan, in line with the promise made by Prime Minster Shinzo Abe, doubled its inflation target to 2% and said it would go in for large-scale monetary easing through asset purchases. In Japan, the idea is to pull the value of the yen down and push exports. The yen has actually fallen about 15% against the dollar since December.
The strategy of intentionally devaluing a currency may work if one country follows it, but it is bound to fail if everyone adopts the same strategy. The entire world cannot export its way to prosperity at the same time. At the end of the day, exports from one country are imports into another. As economists would put it, it’s a zero-sum game.
After the US Federal Reserve, the Bank of England and the Bank Of Japan, if ECB also finds a way of easing and rigging the value of the euro, we will have an all-out currency war. A currency war basically entails competitive devaluation, primarily to push exports and curb imports. The term was coined by Brazilian finance minister Guido Mantega in 2010. Competitive devaluations are unlikely to boost trade and help anyone, and might just end up being just a race to the bottom.
The downsides of a currency war are clear. The easiest way to devalue a currency is to increase its supply. But if all countries start doing this at the same time, the numbers will keep adding. This increased supply of hard cash will attempt to find a parking space for itself and make way towards stocks, real estate, commodities and government bonds, resulting in asset price bubbles. The increased flow of capital will further complicate currency management. Though it is hard to point when and in what shape the competitive devaluations will end, it is a lot easier to foretell that the consequence will not be what you wish for.
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First Published: Tue, Feb 12 2013. 06 56 PM IST
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