While Brazilian Finance Minister Guido Mantega’s statement that the world is the midst of an “international currency war” might be somewhat premature, there is no denying the fact countries today — Japan, Taiwan and South Korea among them — are intervening in currency markets to give their own export competitiveness a shot in the arm, and that these actions, like pitch battles in a war, pose real dangers to the global economy.
As Martin Wolf of the Financial Times points out, the reason for these interventions lie in “deficient demand.” With the world emerging from recession, currency devaluation works like a lever to increase demand for a country’s exports. For example, when Japan intervenes in currency markets and buys US dollars, demand for the yen falls while demand for the latter increases. Done on a large-enough scale, this then leads the value of the yen to dip vis a vis the US dollar. All this makes Japan’s exports more competitive: an MP3 player made in Japan would now cost less to Americans, leading to increased sales for the company that produces them.
At the same time, devaluation makes imports to Japan relatively more expensive (it now costs more yen to import, say, a laptop from America). This then boosts local consumption of goods. (Japanese would then purchase locally-produced laptops, which now seem cheaper in comparison.)
Of course, devaluation is by no means an unalloyed good. Inflation emerges, as imports become more expensive. More importantly, in terms of geopolitics, competitive devaluation is bad because it constitutes what’s known as a zero-sum game, where one country’s gain come at the expense of another’s loss: Japan’s export recovery results in an offsetting loss in America’s. Moreover, there emerges the real risk of retaliatory devaluations and tariff-slapping, as each country tries to preserve jobs and exports at the expense of the other.
The case of China is illustrative. With the recent passing by the US House of Representatives of a bill that could lead to tariffs on Chinese exports, the risk of a currency dispute over the yuan escalating into a trade war has now increased significantly. This scenario, where the world’s two largest economies impose punitive tariffs on each other’s imports, would be disastrous not only for both countries, but would also extinguish the global economy’s fragile recovery. Countries, especially China, should realize that in the long run, prolonged and extensive currency manipulation will likely end in misery for all.
Photo Credit: Bloomberg News