Currency War and Economic Turmoil

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Confronted with intractably slow and bumpy global economic recovery which followed the 2007/08 global economic turmoil, most countries have recently been tempted to resort to undervaluing their currencies in order to gain a competitive edge over their rival economies.

This practice when a country attempts to achieve a competitive stand by devaluing currency to favorably influence the value of its exports is referred to as currency war (“INTERNATIONAL: 2013 could see renewed currency wars” 1).

Just like any other economic conjecture, currency wars have received varied reactions among economists, especially in light of the global recovery progress. I do not wish to delve into the global meltdown recovery topic but rather look at the issue within the realm of macroeconomic outlook of a singular economy.

The fact that currency war relates valuation of currency is influenced by or interrelated to national exchange rate regime. Delving further into the topic of exchange rate regime, two major exchange rate policies are pursued by different economies, namely, fixed and floating exchange rate policies.

Fixed exchange rate regime denotes the practice where country’s nominal exchange rate is determined firmly by the state monetary authority in regard to a particular foreign currency or aggregate of foreign currencies.

In contrast, floating exchange rate regimes let the market determine or accord to the nominal exchange rate depending on the forces of demand and supply; hence, constantly bounding them to fluctuate (Hill 372).

The current exchange rate regimes exercised by world economies, however, would portray purely neither fixed nor floating rate regimes. Rather, the world’s exchange rate system is characterized by a sort of messy blend of floating, managed and pegged currencies combined (Avent 1).

The significance of this kind of mix is that it is now very difficult to certainty point an accusing finger to any single economy seeking to manipulate its currency in a bid to steal others’ aggregate demand and net exports —all the economies do it anyway, albeit at differing degrees.

The danger with this kind of scenario is that the stability of the international monetary and financial system is a public good and depends on the good will of every single state to contribute to their part and safeguard it. Any counteractive action by any single state or economy ripples effect all across the global financial system. Are there any benefits in practicing currency war?

As I have pointed out, the rationale of any country to engage in currency war is to reap from gains of stolen aggregate demand and favorable net exports. Is it an impediment to trade? Well, it depends from what point of view one approaches the topic.

If it is approached from the point of view of the country that is carrying out the game, currency war promotes trade but this is at the detriment of the country, which currency is being castigated.

Currency war does this by importing from countries, which currency has been devalued against more expensive, while simultaneously making exports cheaper and affordable to trading partners (Kenen 109). The net effect is that currency wars neither impede nor promote trade because any resultant trade gains are realized at the expense of depressed trade of the trading partner.

It is difficult to control and completely eliminate currency wars. Depending on an individual country economic situation, different economies are faced with differing macroeconomic scenarios which must be addressed and managed independently.

A country should make use of its available and appropriate mix of both the monetary and the fiscal tools to manage its macroeconomic environment which might not necessarily appease rival trading partner.

A long-term solution would, therefore, be to empower a neutral arbiter, such as the international monetary fund or similar global institution with powers to demand transparency, enforce and approve what is in their reasonable opinion is fair and justified manipulation.

From the U.S. standpoint and precisely with respect to balance of payments, currency war can boost or dim the U.S. balance of payment depending on who wins the war. If we are engaged in currency wars with our trading partners and it emerges that they are able to beat as at it, then this has detrimental effect to our balance.

What this means is that by devaluing their currencies our major trading partners would be able to in the short run attain a competitive edge to push more of their exports to us, while straining our exports to them. Our exports to them will be expensive, while imports from them will be cheap, resulting in positive net exports for them and negative for us.

Any policy that endears the US exports to our trading partners, while discouraging imports, does not only raise aggregate demand for the U.S. goods but also contributes to lessening of the U.S. balance of payment deficit.

An array of policies, such as imports substitution, currency manipulation, the use of tariffs and non-tariff barriers and export incentives, such as tax breaks, are just but a few of the policies that the U.S. can target to reduce balance of payment deficit.

Case review: “Economic Turmoil in Latvia” by Charles W.L. Hill

The case under analysis called “Economic Turmoil in Latvia” is Hill’s classic example of that it is important to have monetary policy independence including using the tools available to suit country’s macroeconomic environment. It is also depicts that it is indeed very difficult to completely eliminate currency wars without overexposing some economies to the vulnerabilities of international financial volatility.

According to the author, Latvia’s economy was very bullish growing in up to 7% of GDP before the financial crisis. However, after the collapse of the real estate market that saw a crisis born in the financial and banking sectors, Latvia was exposed owing to the failure of the availability of internal mechanisms to wield off or at least cushion the vulnerable economy to the huge impacts the crisis resulted in.

Since the country’s currency is pegged in Euro, the small country could not effectively afford to use monetary policy tools at its disposal to regulate interest rates and discourage the cheap and affordable consumption loans to result in out of control inflation.

The bullish but false economic indicators, just before the crisis also endeared an influx of capital and foreign investment which further exacerbated the impact as the crisis hit all these, was quickly and with no prior warning withdrawn.

As such, what the author seeks to bring to the attention of the reader is that although we are talking of currency wars and how floating exchange rate regimes would eliminate such wars, it is also important that economies retain their own strong internal monetary policy controls.

Works Cited

Avent, Ryan. “Of course you realise this is nothing like war.” The Economist. 13 Oct. 2010. economist.com. Web. <https://www.economist.com/free-exchange/2010/10/13/of-course-you-realise-this-is-nothing-like-war>.

“INTERNATIONAL: 2013 could see renewed currency wars.” Oxford Analytica. 12 Dec. 2012. Proquest. Web.

Hill, C. W. L. (2012). International Business: Competing in the Global Market Place. 9^th Ed. New York: McGraw Hill Education.

Kenen, Peter B. (2000). “Fixed versus Floating Exchange Rates”. Cato Journal, 20.1(Spring/Summer 2000): 109-113. cato.org. Web. <https://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2000/5/cj20n1-13.pdf>.

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Currency War and Economic Turmoil

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