Currency wars can best be defined as a “competitive devaluation” of a national currency.
Think of currency wars as the purest form of competitive devaluation for financial warfare purposes.
Under such conditions the value of currency can be a “make or break” for a national economy. A currency that is too high can push down export demands. If it is too low, it could cause imports to be too expensive and cause higher inflation rates.
The International Monetary Fund (IMF) defined these actions in 1976 when it revised its charter to warn of policymakers “manipulating exchange rates…to gain an unfair competitive advantage over other members.”
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The objective of currency wars are to boost national exports through gaining advantage of cheaper goods compared to foreign competition. If another country does not match in currency devaluations, then exports from the non-actor will be negatively impacted.
The currency at the center of global currency wars is the U.S dollar. The dollar continues to face competitive devaluation that plays out in the story of lower prices, avoidance of U.S dollar paper assets and varying economic policy.
By understanding the origin of currency wars, exactly how they undermine effective policy and what the future may hold can leave you and your money better positioned for the future.
History of Currency Wars
At the onset of the great depression that hit western industrialized countries starting in 1929, rampant unemployment continued to compound problems in the international financial system.
The British empire, a country once at the center of this industrial boom, was ailing. Following a German devaluation from gold at the beginning of 1931, the British pound sterling and its economy were being hammered with economic shock. While the move from the German central bank was speculative in devaluation, it was one that would have dire consequences.
Minutes from the Bank of England’s court in 1931 show that the central bank was having its foreign exchange reserves drained by speculative accounts. The U.K’s central bank felt it had to make a move.
Finally, in September 1931, Britain formally abandoned the gold standard to devalue the pound sterling.
Acting along with the decision from London, the majority of the countries that fell under the British Empire, or were heavily connected to the U.K, exited the gold standard in later that year.
Originally, the gold standard was to be a preventative measure that would ensure that other countries would not print a flood of paper currency. Now all bets were off.
As countries proceeded to exit the gold standard, they simultaneously devalued their currencies. Economist often refer to this retaliatory move as a “beggar thy neighbor” policy where, through exports moves, they could literally export unemployment.
The global economy looked on in horror. The great depression had spread throughout the West.
By June 1933 world leaders gathered for the World Economic Conference to repair the damage being experienced during the economic downturn. The U.S dollar had dropped considerably and global currency markets were struggling to understand exchange rate agreements that had once been traditionally accepted.
Ironically absent at the time was U.S president Franklin D. Roosevelt but his resounding message would send out devaluation shocks across the world.
Sending out a historic cable wire to the London Conference, Roosevelt pinned to his delegation and world leaders at the Conference in July 1933:
“So too, old fetishes of so-called international bankers are being replaced by efforts to plan national currencies with the objective of giving to those currencies a continuing purchasing power…”
“The sound internal economic system of a Nation is a greater factor in its well-being than the price of its currency in changing terms of the currencies of other Nations.”
What FDR meant by this rather long-winded cable was that the internal forces were pushing toward a competition of currency. A currency war.
This groundbreaking statement from the U.S, a country yet to emerge as a true global superpower, sent leaders into a spiral of pushback. The legacy of the London Conference was one that divided the world from once acting cooperation, to now imposing rising tariffs, implementing levied import controls and sending out massive restrictions on capital flows.
The combination of the U.K split with gold and a U.S devaluation against gold that occurred in 1933 promoted the intended currency war tactic. Both economies competitive devaluations prevented prices from falling, allowed money supplies to increase and bolstered production.
The division between states created a chasm in cooperation.
While this lack of international unity was not the sole catalyst to the destruction of peace that brought World War II, it was a part of a growing rivalry that would eventually experience real war.
Since then, financial competition between states and currency values have been in flux. The general floating of currency became custom.
Currency Wars and King Dollar
The U.S government understood the role of the emerging dollar. In 1971 U.S Treasury Secretary John Connally told foreign finance ministers during an international gathering, “The dollar is our currency, but it’s your problem.”
King dollar had arrived.
By March 1973, after President Nixon had removed the U.S from the gold standard, other major global currencies began to float against one another. Following World War II the United States had emerged as a major global power. The U.S dollar had risen as the world’s foremost currency.
Countries were no longer accepting gold as a peg to national currency values, but instead accepting one another, to value their currency standards (if you’d like more on the death of the dollar and floating currency – CLICK HERE).
In the sphere of currency wars, there were some areas that this floating would holistically impact the new international monetary system – there were also exceptions.
The first exception to this was when the economies of Europe came together to form a single currency as part of the European Union in 1999. This arrangement caused countries to discontinue use of their national currency for a multinational European currency – the euro.
This caused participating EU member states to act in faith together, instead of floating each national currency against one another, to determine value.
While some European members continue to refrain from the single currency market (Switzerland, Czech Republic, Norway, etc) the ability of the euro diminished floating competition in Europe while offering a rivalry to the U.S dollar began.
The other major exception was a supranational float that occurred in the currency wars age was found in Asia.
As a non-dollar crisis the Asian financial shock that began in 1997 was first triggered by the collapse of Thailand’s currency. This collapse would spread throughout the region in a contagion of sweeping currency devaluations.
Southeast Asia found itself unable to pay debt obligations, maintain financial order and with frozen bank trades. Members of the ASEAN bloc that were part of the Asian financial crisis experienced up to 180% of debt-to-GDP while, by one estimate, accounted for 40% of overall U.S trade.
The contagion left emerging economies in the region in need of a bailout. The IMF will fill that void with a bailout which was packaged with immense stipulations on debt repayments. It also required greater reserve build up.
Emerging economies in the region now would now maintain a policy of intervention in order to keep their currency values low. It also brought the need to build central bank reserves
King dollar was not only supreme, it was policy.
The desired option from Asian central bank’s was to build up U.S dollar reserves and devalue their respective stock markets along with other asset prices.
The new normal for currency wars had been crafted.
Major shifts in trade, market prices and massive overhauls in capital flows would disrupt economies both in Europe and Asia alike as currency war devaluation was just beginning.
The dollar would soon encounter an even greater currency war threat, one that was by its own doing and superseded the economic bloc’s of Europe and Asia.
While the financial crisis in Asia or creation of the euro did not negatively impact the dollar, it would eventually be so interconnected with the U.S currency that once the global financial crisis hit – there was no separation.
In the face of the global financial crisis, irrational actors would make irrational moves – that has been the story since 2008.
Currency Wars and the Global Financial Crisis
At the height of the global financial crisis that began in 2008, the IMF released its World Economic Outlook for 2009 where it reported that global growth was projected to fall by its lowest rate since World War II.
Economic conditions were at a severe downtown and global trade had hit record lows declining by 12%. A new currency war was overdo.
Source: IMF World Economic Update
A strategy for exports being the driver of economic activity to get out of economic trouble became the global norm.
Advanced economies began to lag behind with growing national deficits. This began while emerging economies, that were not as interconnected globally, did not need to weaken their currency to match the once strong dollar.
Brazil’s finance minister, Guido Mantega shot out a warning in September 2010.
While speaking on behalf of many countries in similar position he lambasted, “We’re in the midst of an international currency war,” as he addressed of industrial leaders in Brazil. “This threatens us because it takes away our competitiveness. The advanced countries are seeking to devalue their currencies.”
The Brazilian minister highlighted a series of interventions from countries (Japan, South Korea, Taiwan) that were sending out major currency devaluations. This would cause major trade imbalances throughout the world.
One of the leading Wall Street banks, Goldman Sachs, monitored in the wake of the devaluations that currency inflows were hitting an annual rate at just over half a trillion dollars in Asia over the course of 15 months. Across the world in currency inflows were at nearly $74 billion in Latin America. Investors and governments were waking up to the reality of a real currency war.
That type of money movement because of currency devaluation threatened stability and even brought warnings of “direct capital controls” discussions from major Wall Street banks. In the instance that capital controls begin, international trade becomes nearly impossible.
John Butler, author of The Golden Revolution, was featured in the Daily Reckoning at the time where he wrote in a Star Wars fashion Begun, The Currency Wars Have.
He pinned, “It is perfectly normal for trade to contract when growth contracts. But when trade barriers are raised they become the cause of contraction rather than the effect.” These words would come to haunt the Obama administration and its international trade position with China.
By September 2010, President Obama’s Treasury Secretary was speaking to members of Congress about what exactly to expect from global trade and in particular their expectations on Chinese trade policy.
While speaking in sworn testimony before the Senate Banking panel, Secretary Tim Geithner criticized the Chinese exchange rate policy while saying he intended to use “all tools available.” Though Geithner did stop short of officially labeling China a “currency manipulator” he did note that his administration would do everything in its capacity to “end discriminatory trade and investment measures.”
The G-20 (Group of Twenty) gatherings have had repeated focus groups and heads of state discussions on the international obstacle of currency wars and the global economy. The international gatherings would be an opportunity for elites, leaders and their finance ministers to discuss the issues facing finance and their respective economies.
The threat of currency devaluations was found in the struggle between the dollar and major rival economies. A competitive dollar against the Chinese yuan continued to surface.
This came front and center in 2013 when the G20 held in St. Petersburg Russia unanimously pledged to avoid currency wars all together.
The official G-20 2013 statement read “We will refrain from competitive devaluation. We will not target our exchange rates for competitive purposes.”
Since then the global economy has done little, if anything, to not actually target exchange rates for the purpose of currency war competition.
These types of regular renewals not to embrace currency war policies by the G-20 are frequent in nature, but have never once singled out one individual country.
The rise and influence of the G-20 can best be summed up by their growing admissions and lack of tangible action. As the Deputy Finance Minister Sergei Storchak told a group of reporters once, “There is no competitive devaluation, there are no currency wars, what’s happening is market reaction to exclusively internal decision making.”
Currency Wars and Donald Trump
Donald Trump has taken direct aim at currency manipulation. Much of the President’s targeted attention has been focused on China, Mexico and the EU. His swirling concern has been focused on the perceived threat of over currency values, trade and the threat of imports remaining comparatively low.
When speaking on how he would bring jobs back to the United States, Trump lambasted,
“You look at what China is doing to our country in terms of making our product. They’re devaluing their currency, and there’s nobody in our government to fight them… they’re using our country as a piggy bank to rebuild China, and many other countries are doing the same thing.”
“Our country’s in deep trouble. We don’t know what we’re doing when it comes to devaluations and all of these countries all over the world, especially China. They’re the best, the best ever at it. What they’re doing to us is a very, very sad thing.”
In the midst of the 2016 election cycle his campaign heralded a policy platform to label China as a currency manipulator. Though campaign rhetoric tends to be one thing and reality another, Trump has been prudent in attempting to follow through on his promises. While language that once directly focused currency manipulation is no longer on his campaign page, or even the White House official page, a focus on currency war activity has been a cornerstone of the Trump economic agenda.
Trump Tweet on China: Currency devaluation
Did China ask us if it was OK to devalue their currency (making it hard for our companies to compete), heavily tax our products going into..
— Donald J. Trump (@realDonaldTrump) December 4, 2016
Trump Tweet on Mexico: This is just the beginning
Thank you to Ford for scrapping a new plant in Mexico and creating 700 new jobs in the U.S. This is just the beginning – much more to follow
— Donald J. Trump (@realDonaldTrump) January 4, 2017
Even before Trump entered office challenges had already been mounting. During the same time that Trump had heightened his currency war rhetoric, a concerted pushback was underway. The democratic lead White House together with China released a public statement in September 2016 laying out an agreement that they would refrain from entering into an economic currency war.
“The United States and China jointly reaffirm their G-20 exchange rate commitments, including that they will refrain from competitive devaluations and not target exchange rates for competitive purposes,” the White House said Sunday, a day after a meeting between U.S. President Barack Obama and Chinese leader Xi Jinping.
While the official White House press release may have assembled all of the necessary policy tools – the G20 along with the rise of Donald Trump may have diminished any of the porous hopes of actual bilateral cooperation.
Trump has even taken on those that were presumably long-time allies in Europe. President trump’s nominee, Ted Malloch as the Ambassador for the European Union, has clearly directed policy toward a combative currency environment.
Malloch, while speaking to the BBC, remarked directly that, “The one thing I would do in 2017 is short the euro, I think it is a currency that is not only in demise but has a real problem and could in fact collapse in the coming year, year and a half.”
This type of an approach clearly signals a contention with single currency systems and an intent to promote government leadership through representatives that openly promote a currency war agenda.
Currency Wars and China
Stemming from the tweets sent out from Donald Trump, the Chinese currency has been increasingly vulnerable to international rhetoric and retaliatory policy. While China may, in fact, be a currency manipulator – it is not alone.
In August, 2015 China made a shocking move to actually devalue its currency. The People’s Bank of China, China’s central bank, cut its daily rate by 1.9 percent.
This move brought about the yuan’s most severe one-day drop since China nixed its dual-currency system back in January 1994. As Asia’s largest economy and one of the most powerful export economies in the world, the move by China got immediate pushback.
The focused threat was that China would continue, as they indeed have, to further devalue their currency while being pegged to the U.S dollar along, with a basket of other currencies.
The Chinese yuan officially entered the International Monetary Fund’s special drawing rights, world money, basket in 2016. The U.S policy, once opposed to the inclusion of the yuan in the world money basket, formally announced its support for the move. This move now presents a growing complexity over the Chinese currency and a devaluation war that the Trump administration will have to face.
Under the Trump administration, an escalation of currency wars could result in trade war activity between the U.S and China. While currency war implications may not be the catalyst, they could be an outcome. These types of growing economic tensions could trigger higher prices on sectors ranging from food, oil, stocks to bonds and other securities.
Jim Rickards indicates that the Trump administration is already taking steps to counter Chinese currency moves.
He reports, “Trump is just laying down markers and putting China on notice. In fact, it looks like Trump will use trade authority and the Commerce Department to compensate U.S. industries hurt by China’s cheap currency subsidies.”
Rickards’ highlights concerns over such currency war activity stating, “This means China may get a “green light” to devalue, but they will pay the price in other ways, such as selective tariffs and subsidies to U.S. competitors.”
Currency War Weapons
The world economy continues to beat the financial war drums away from economic cooperation. While central bankers are not typically active in war, they do have open financial weapons at their disposal.
The global economy can be a place of both financial opportunity and economic devastation.
No longer has it proven to be the status quo policy of national governments to seek cooperation toward financial well-being for mutual gain.
The international rhetoric around currency wars tends to circle in on the ability of a government or its respective central bank to efficiently distort demand for its products, and its currency.
One of the first and most impactful currency war weapons used is what central bankers often reference as quantitative easing. Quantitative easing, in various forms, has been a method of central banks ranging from the Federal Reserve, Bank of Japan and the European Central Bank to implement a policy of money printing in order to buy bonds.
This method superficially allows for central banks to bolster or distort economic numbers for demand.
Central banks have also established a method to insert themselves, artificially, into markets with the intent of currency intervention. This currency war method allows for a central bank to raise, lower or artificially position exchange rates. The results allows central banks to intervene in money markets, impact import-export trades and alter financial outcomes in exponential ways.
A third method used in a currency war has been labeled as the “nuclear option.” Mark Gilbert, a Bloomberg financial columnist, identified the method of unleashing capital controls as the ultimate act in a currency war. Gilbert labeled capital controls as “the introduction of taxes and prohibitions to regulate the flow of money into and out of a nation.”
Ultimately, it would be a restriction of cash and highly dictate free and open markets. While Central Banks like the Federal Reserve continue to push for higher interest rates, the irrationality of others may soon look toward such a nuclear option in retaliation.
How to Stop a Currency War
There is a concerted debate over how long the world’s economies can continue to push back against one another. There is even greater discussion on how they might seek an “economic peace.”
Famed economists Barry Eichengreen and Douglas Irwin, both scholars considered preeminent dollar specialists, have made the argument that central banks have not actually put forward all of the tools at their disposal. They contend that if the central banks were to do so, the such actions would cause a relinquishing of deflation and provide a desperate boost to the employment rate in response.
The scholars have also concluded that the world may be capable of existing with multiple reserve currencies.
This may be an ideal scenario of international monetary “kumbaya.” The reality is that the world’s most powerful central banks are not likely, if ever, to act with with a united monetary policy in contrast to monetary retaliation. It also neglects to highlight the need for as systemic “anchor” that in the instance of economic shock, the international monetary system could harbor.
The lack of a “missing financial anchor” in the global economy could also be a contributing factor to the dominance of the U.S dollar. While many offer tangible solutions, the final belief that gold is the ultimate anchor could reemerge as a steady and stabilizing monetary force.
It has also been proposed that a flexible gold standard could alleviate continued volatility and uncertainty that push inflation and throw both interest rates and exchange rates into chaos.
Austerity, stimulus, regulation and devaluation of exchange rates continue to flourish in the currency war era. All factors that can choke demand, investment and markets. They’re also factors that promote a protectionist response.
It is within those forces pressing forward a currency war that we find the answer to solving it. By working to stabilize the financial system and avoid radical currency manipulation, the largest detriments to currency wars can be solved.
Who is Winning the Modern Currency War?
In the graphic featured, the currency wars are visualized in a literal race to the bottom.
The countries that have devalued at the highest negative percentage rate receive the greatest economic advantage. At the same time, those the have had the highest appreciation, have the greatest exports and trade concerns.
The visual shows data from the Bank for International Settlements, the bank for central banks, that evaluates effective exchange rate changes from 2012-2016. Currently, Russia stands with the greatest percentage devaluation over that time period of the seven currencies selected – while the U.S dollar has the greatest rise.
Currency Wars Going Forward
In a recent financial editorial from Barron’s, a frequent Wall Street outlet for economic analysis, ran the headline, “Currency Wars Are the Big Threat to Global Trade.”
In the world of global trade and bilateral agreements – exchange rate destabilization would negatively impact economic conditions and financial markets. This story continues to play out as a threat not only to global trade – but to the currency market systems as a whole.
Economist and bestselling author, Nomi Prins perfectly summarizes that what “started as currency wars that centered on advantages in trade flow and balances, has grown to encompass geo-political power. The incentives of regulating
or manipulating currency value, particularly in world rife with speculators, is not entirely about surpluses and deficits for international trade.”
“This competition for economic benefit in currency wars by nations goes further. The ability to attract foreign capital to support infrastructure projects and economic growth matters. It allows countries to enhance their positions of strength in the global power hierarchy.”
Central banks have signaled that since the global financial crisis of 2008 they have a desire to diverge economic policies. Global demand in the face of currency wars needs a rebalancing. Countries that are heavily in debt, experiencing massive austerity measures and various currency devaluations cannot truly be competitive.
Yes, China has been a part of currency measures that could heavily be argued as currency war practices. But, they are not alone. The United States, Europe and Japan are also all complicit. This is not a time for complacency. The threat of devastating economic policies and escalating corporate infighting are global destabilizers that can, and in many ways will, impact us all.
As Jim Rickards noted in his New York Times bestselling book Currency Wars, “There is nothing today that suggests the currency wars will end anytime soon. The Federal Reserve and the U.S Treasury persist in their efforts to cheapen the dollar.”
“Currency wars are ultimately about the dollar, yet the dollar today is just a jumped-up version of its former self due to derivatives, leverage, printing and the derogation of gold. It is not past time to save it. Still, the time grows short.”
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