The Currency War

The world is gradually moving out of recession with the emerging economies doing it quickly while the developed world on the rise as well albeit a bit slowly. However the recovery has been much faster than expected due to the cohesive action, unprecedented before, of all central bankers. Some economists though are skeptical of the recovery and fear a double dip recession though not as difficult as the one in 2008-09.

On the contrary, currently the developed world's central banks are moving at varying speeds and intensity to respond to a weak recovery so as to reduce the risks of a global deflation and restrain their currencies from rising against those of their trading partners. They all are working through indirect ways to spur growth. Initially it was the fiscal action, now it is monetary action. Currency bring used to gain cost advantage over other countries.

The currencies being kept artificially low to make exports lucrative. China is the best example of a country who has managed to keep the yuan artificially low. During the boom years, no one bothered but now with growth difficult, every one is walking down the same path. Brazil is doing it so is Japan. The US can’t do it because it’s the global currency and its strength depends as much on its economic policies as on the other world currencies.

Central bankers elsewhere are strongly indicating that they are preparing to reduce interest rates to reflate their economies at a time when fiscal policy has started to reduce to follow fiscal prudence. Developed economies such as those in Western Europe have to go in for austerity measures to survive. So currency weakening seems to be the best solution.

This solution though is a very short term measure. Fundamentals will not be the reason for recovery which will be artificial and fragile. Though the attempt by the US, Japan and Europe to pressurize china to let its currency--widely regarded as undervalued--rise faster.

If exchange-rate policy is being used for growth, then it would inhibit the global imbalances in trade highly favoured for export-oriented China and consumption addicted developed markets.

With low interest rates, money is flowing in emerging markets such as India, China and Brazil who have stared to increase interest rates for fear of inflation. This excess flow of funds is upping their stock indices and putting upward pressure on their currency. Thus the actions by countries to restrict funds inflow and keep their currency appreciation under control. This is resulting in currency wars by all countries throwing the effects of globalization out of the window. This isn’t going to make the situation any better. It will just delay the inevitable.