CURRENCY WARS

INTRODUCTION:-

Currency war, also known as competitive devaluation, is a condition in international

affairs where countries compete against each other to achieve a relatively low exchange
rate for their home currency, so as to help their domestic industry. Xinhua defined a
currency war as "situation where one nation, relying on its strong economic power,
buffets its competitors and seizes other nations' wealth through monetary and foreign
exchange policies. It is a form of economic warfare with cold premeditation, specific
purpose and considerable destructive power. Competitive devaluation has been rare
through most of history as even at times when a system of fixed exchanges rates has not
been in place, countries have generally preferred to maintain a high value for their
currency or have been content to allow its value to be set by the markets. An exception
was the widely recognized episode of currency war which occurred in the 1930s.

The currency war of the 1930s is generally considered to have been an adverse situation
for all concerned with all participants suffering as unpredictable changes in exchange
rates reduced international trade. The 2010 outbreak of competitive devaluation is being
pursued by different mechanisms than was the case in the 1930s and opinions among
economists are divided as to whether it will have a net negative effect on the global
exchange.

REASONS FOR INTENTIONAL DEVALUTION:-

Currency devaluation has several adverse consequences on a state. It can lead to a

reduction in citizen's material standard of living as their purchasing power is reduced
both when they buy imports and when they travel abroad. It can push up inflation.
Devaluation can make international debt servicing more expensive if debts are
denominated in a foreign currency, and it can discourage foreign investors. A strong
currency is sometimes seen as a mark of prestige while devaluation is sometimes seen as
a sign of a weak government

However when a country is suffering from high unemployment or wishes to pursue a

policy of export led growth, a lower exchange rate can be viewed as a potential solution.
A lower value for the home currency will raise the price for imports while reducing the
price for exports. This encourages more production to occur domestically, which raises
employment and GDP. Devaluation can be especially attractive as a solution to
unemployment when other options like increased public spending are ruled out due to
high public debt and also when a country has a balance of payments imbalance which a
devaluation would help correct. A reason for preferring devaluation common among
emerging economies is that maintaining a relatively low exchange rate helps them build
up their foreign exchange reserves, which can protect them against future financial crises.

WHAT ITS IMPACT ON WORLD ECONOMY?

Currency wars are a part of what is described as a ‘beggar thy neighbour’ policy —
attempts by a country to solve its economic problems by causing worse difficulties in
other markets. When all countries engage in such policies, it turns out to be a race to the
bottom. As countries compete to devalue their currencies to save the interest of their
exporters, it collectively reduces demand for foreign goods, something that world
economies cannot afford at a time when the process of global recovery from the after
affects of the crisis of 2008-09 is still underway. Also , competitive currency devaluation
is happening at a time, when some of the developed economies have a soft money
situation, wherein monetary regulators are on a quantitative easing spree, lowering their
interest rates, which is making emerging economies trying to regulate their inflation an
arduous task, as direction of the capital flows has turned towards them. There is also the
fear of a bubble, which will burst once developed economies are back on track and the
flow of capital shrinks. This shrinking is expected to be first reflected in the currency
markets.

CURRENCY WAR IN JAPAN

The Bank of Japan’s surprise move to reinstate zero interest rates has led to a warning of
the danger of a currency war from the head of the International Monetary Fund.

Dominique Strauss-Kahn warned that moves by central banks across the world to cut
interest rates and carry out billions of pounds worth of quantitative easing could upset the
global economy recovery as currencies chased each other ever lower.

In an interview with the Financial Times, he said: “There is clearly the idea beginning to
circulate that currencies can be used as a policy weapon. Translated into action, such an
idea would represent a very serious risk to the global recovery ... Any such approach
would have a negative and very damaging longer-run impact.”

Japan surprised markets by adopting a zero interest rate policy and announcing plans for
quantitative easing (QE) in an attempt to inject fresh stimulus into the economy.

The move led to an immediate fall in the value of the yen against the dollar.
The Japanese central bank has pledged to buy assets worth five trillion yen (£38bn) and
cut its overnight rate to between zero and 0.1pc,from 0.1pc, reinstating the so-called
“zero interest policy” that the Bank only ended in July 2006.

It will keep its benchmark rate effectively at zero until establishing price stability,
adopting a similar loose policy commitment to the US Federal Reserve.

The size of the QE programme roughly matches the extra stimulus package desired by the
Japanese government. Japan is running out of options as it seeks to reinvigorate its
economy in the face of national debt running at twice the national output – the largest of
the advanced economies.

It is also trying to counter the yen’s strength, which has been one cause of the country
dipping in and out of deflation over the past 15 years. Lingering concerns about the
global economy pushed the gold price up 1.8pc to another record high, of $1,340.20 an
ounce.

Japan is not the only country enact policies that could suppress the value of its currency.
Brazil recently threatened to intervene to keep the real down and earlier this week
doubled taxes on foreign investors buying Brazilian bonds. The move was seen as way of
stopping large inflows of foreign currency pushing up the value of the real.

Mr Strauss-Kahn was speaking ahead of this week’s IMF and World Bank annual
meeting.

YEN WEAKENS AS BANK OF JAPAN SURPRISES MARKET WITH RATE

CUT

The Bank of Japan on Tuesday pledged to pump more funds into the struggling economy
and keep interest rates at virtually zero, surprising markets and stealing a march on the
Federal Reserve in providing a fresh dose of economic stimulus.

For months, the central bank had eschewed government calls for more decisive action,
such as buying more government bonds, focusing instead on a limited funding scheme.

But in the face of growing evidence that the yen's strength was hurting the economy, the
Bank of Japan cut its overnight rate target to a range between zero and 0.1pc from 0.1pc
and pledged to buy 5 trillion yen worth of assets.

It also said it would keep its benchmark rate effectively at zero until price stability is in
sight. Core consumer prices have been falling from a year earlier since early 2009.

The purchases would roughly match the size of extra stimulus being considered by Prime
Minister Naoto Kan's cabinet.
The assets, ranging from government bonds and short-term government securities to
commercial paper and corporate bonds, would come under a temporary scheme that
would also cover 30 trillion yen of such assets as collateral under an existing loan
programme.

"The BOJ is bringing its monetary policy closer to quantitative easing, allowing market
rates to hover near zero and pledging to keep a near-zero interest rate policy in the longer
term until prices stabilise," said Naomi Hasegawa, senior fixed-income strategist at
Mitsubishi UFJ Morgan Stanley Securities.

BOJ policymakers have signalled in past weeks that they were considering a further
easing of policy after Tokyo's intervention in the currency market in mid-September to
check the yen's strength offered only temporary relief.

Most market players, however, had expected the central bank to opt for a relatively minor
adjustment of its 30 trillion yen loan scheme that supplies banks with funds at its 0.1pc
rate.

"These steps are more aggressive than markets had expected. The BOJ's decision is a
surprise and will have an impact on currencies due to the message it delivers."

The surprise move weakened the yen against the dollar, pushed up Japanese government
bond futures and helped stock prices turn positive.

The decision to cut interest rates was made by a unanimous vote, but board member
Miyako Suda opposed the inclusion of government bonds among the types of assets the
BOJ could buy using its pool of funds.

The BOJ is not the only central bank under pressure to do more to support an economy
that is showing signs of faltering.

Financial markets expect the Fed to embark upon another round of asset buying to bolster
a sluggish recovery as early as its November meeting. There are also calls within the
Bank of England for further easing, although the bank has kept markets guessing on
whether it will indeed do so.

In Japan, slowing export growth, a surprise fall in factory output and companies' worries
that the strong yen may hurt the outlook have heightened the case for the central bank to
ease policy.

The BOJ had already been edging nearer to quantitative easing by allowing the yen
pumped into markets through currency intervention to remain in the financial system,
instead of draining it.
CURRENCY WAR IN BRAZIL
The world is in an "international currency war" as governments manipulate their
currencies to improve their export competitiveness, said Guido Mantega, the Brazilian
Finance Minister. Mr Mantega's speech to Brazilian industrial leaders on Monday
included some of the strongest comments to date by any senior government official on
the recent bout of currency intervention by countries, including Japan and China.

Brazil's currency, the real, is now the world's most overvalued major currency, according
to Goldman Sachs.

Near a 10-month high against the dollar, the real continued to rise after Mantega's
comment as traders bet the government may be waiting for the outcome of Sunday's
presidential election before taking action.

We're in the midst of an international currency war," Mr Mantega said. "This threatens us
because it takes away our competitiveness."

With some economies still reeling from the global financial crisis, countries have sought
to weaken their currencies to boost exports and improve trade balances.

Currency intervention is likely to be a hotly disputed topic at the next meeting of the
International Monetary Fund in Washington, DC, on October 8 -October 10.

Japan, Colombia, Thailand and other countries have been seeking to weaken their
currencies to help accelerate their economic recovery.

Low interest rates across much of the developed world have also prompted investors to
pour cash into higher-yielding assets in countries such as Brazil, causing further outcry.

"The advanced countries are seeking to devalue their currencies," Mantega said,
mentioning the United States, Europe and Japan in the context of what he portrayed as an
intensifying trade competition.

Mr Mantega has repeatedly tried to talk down the real. The government last week
threatened to use the sovereign wealth fund to buy dollars.

But the government has been reluctant to follow through with concrete measures, and
traders bid up the currency near the 1.70 per dollar level, which some see as the threshold
for new, stronger action by the government.

Last week's share offering by state-oil company Petrobras contributed to a large inflow of
dollars to Brazil, which is attractive to foreign investors because of high interest rates and
its booming economy.
Mr Mantega said the country still has an arsenal of tools available to weaken the real,
although he did not offer details. Mantega said the government was not considering
additional taxes on foreign investments but noted that the government has imposed such
controls to hold back the real in the past.

The remarks could be a sign that Brazil's government will beef up efforts to weaken its
currency, said Raphael Martello, an analyst with Tendencias consultancy in Sao Paulo.

"He could be preparing the way for a stronger intervention. Since Japan intervened in the
currency market, it gave other countries a justification to do the same thing," Mr Martello
said.

Japanese authorities intervened to sell yen on September 15, the first such intervention
since March 2004, while the United States has vowed to rally global heavyweights on
China's currency, the yuan, which many economists say is undervalued

TROUBLES OF CREDIT CRUNCH AND RECESSION

The trouble with this “currency war” is that both sides have a compelling argument. In
effect those who are trying to de-value their currencies are doing so to boost flagging
economic recoveries. These economies are mostly in the developed world. On the other
hand, the world’s big exporters who managed to avoid recession during the credit crunch
are worried about appreciating currencies causing growth problems of their own. This is
mostly a problem for the emerging markets.

So the battle is really between those with budget surpluses and those with budget deficits
(see chart). This isn’t going to be easy to sort out. Throughout this recession there hasn’t
been the great re-balancing of economies that some predicted. US imports continued to
surge in the second quarter and UK exports remain anaemic at best. But the “weapons”
used in a currency war aren’t that effective at sorting out the imbalances. For example,
the trade –weighted dollar index might have fallen 10% since May, but it remains a
further 10% from the low reached in mid-2008 when the index hit a low of 71. During the
last period of fiscal stimulus in the US, the dollar actually appreciated as investors treated
it as a safe haven asset.

In the same way, the Swiss National Bank abandoned FX intervention in 2009 after
spending more than 100bn francs. Currently the franc is below parity against the dollar
and 1.32 versus the euro. On the other side, emerging markets that are seeing strong
growth and large capital flows, risk stoking inflation if they keep their currency weak.
The problem is that in this environment of fragile global growth, all countries want a
weak currency. That’s not going to happen and investors will have to decide who
appreciates and who goes down.
The best outcome would be for the global economies to reach some happy medium. The
developed world needs to spend less and vice versa for the emerging world. But this
deleveraging/ re-leveraging is going to be a painful global process.

Throw politics into the mix- the US are voting on whether or not to formally
acknowledge China as a “currency manipulator”- and the whole process gets more
complicated.

What will it mean?

But what does this mean for investors? With multiple countries trying to keep their
currencies low, this should limit trading to a range and investors may see less of trending
markets. Also, investors might bias themselves against the developed market currencies
instead favouring emerging markets, with stronger economic fundamentals, as we
mentioned in our quarterly outlook that you can reach here

In terms of specific pairs, the dollar could be under more pressure than the euro as long as
the ECB remain less dovish than the Fed. Also, the Chinese authorities may allow the
Yuan to appreciate gradually against a basket of currencies over the coming years. But
the asset that will be the chief beneficiary is gold, which isn’t controlled by a central
bank. And estimates of $1,450 within the year for an ounce of the yellow metal don’t
look outrageous.

EFFECTS OF CURRENCY WAR

Rising Foreign Currency

The depreciating US dollar has resulted in the strengthening of foreign currency. Take the
singapore dollar for example. The Singapore Dollar has been on the rise ever since
March of 2009. A few weeks ago, the monetary authority of Singapore has has increased
the trading range of the Singapore dollar, effectively giving the Singapore dollar more
room to appreciate against the US dollar.

Inflated Asset Prices

As money is being created out of thin air, the global supply of money increases and a
large proportion of this flows into developing countries in search of better yields. This
has led to recent surges in the prices of assets such as stocks and property. This is the
onset of dangerous bubbles that need to be kept in check.

As a result, countries such as China and Singapore have implementing taxes and new
restrictions in order to cool the market
Global Inflation

One of the consequences of a weakening US dollar is inflation. There has been a major
surge in the prices of many commodities. The price of wheat has increased by about 30%.
The price of corn in the past year has increased by about 50%.

We use corn to make all sorts of things from cornflakes to diapers to soft drinks. In a
typical grocery store, at least a quarter of all of the products use corn in some form or
another in production or processing. Thus you can imagine that if the price of corn goes
up by 50% in a single year, there will be serious inflationary consequences down the
entire supply chain

CONCLUSION
In conclusion, the currency war is a current huge global phenomenon that has huge
implications on all of us. The process of global economic recovery is fraught with
uncertainties as the US attempts to lead the world out of recession through the creating of
wealth out of thin air, and this has huge implications in the aspects of asset prices as well
as inflation rates. We need to keep learning and developing oneself, be mindful of the
possible implications as well as to stay on top of the issues at hand.