Published On: Tue, Feb 5th, 2013

The Currency War of the World

The onset of the Great Recession of 2008 proved to the world the un-sustainability of too much debt and too much leverage. The first phase of the crisis witnessed concerted and coordinated action by the Central Banks of the world, which translated into massive stimulus spending to spur growth and repair the balance sheets of the troubled banks. The recession morphed into a sovereign debt crisis in the Eurozone and in the United States. As it was no longer private sector debt or consumer debt that was the problem, governments across the world were faced with difficult choices as to the course of action that needed to be taken. Because the crisis was seen as a result of global imbalances between the United States and the rest of the world (especially China), the cure was thought to be one where the Chinese Yuan is allowed to appreciate in value leading to lesser imbalances with the United States in terms of foreign currency reserves.

However, the problem with allowing the Yuan to appreciate is that it makes the Chinese Exports uncompetitive and given the rather poor domestic consumption rates in China, the net result (from the Chinese perspective) would be disastrous. On the other hand, there was a serious case for the maxed out American consumer to consume less and the heavy saving Chinese consumer to consume more. This is the genesis of the Currency wars that are now threatening to rock the global order. The way out is painful and involves rebalancing the global order with the steps mentioned above. Given the fact that there is lot of short-termism in the world, no country wants to be the one, which has to prescribe the bitter medicine to its citizens. Hence, the renewed threat of currency debasing and protracted currency wars has to be seen in this context.

In recent days, it has become clear that Europe is joining the Currency War bandwagon with the Bundesbank (Germany’s central bank) warning against a strong Euro. With the Federal Reserve indulging in unlimited bond buying, it is clear that the USD is heading for a drop. Further, the Fed’s actions are creating asset bubbles all over the world. Indeed, this is a volatile situation for the global economy and something that can be resolved only through mutual cooperation and coordinated action.

In the immediate aftermath of the crisis in 2008, central banks and governments across the world agreed not to let currency wars take hold. However, that was short-lived, as within a couple of years, protectionism and debasing of one’s currency became the norm. As mentioned earlier, unless there is a structural adjustment, the global economy is likely to be prone to shocks and currency wars. This is the overarching theme that emerges from a study of the financial system at the moment. In conclusion, unless global imbalances are rebalanced, currency wars are going to predominate leading to a situation that is detrimental to all parties in the longer term.

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.