What is a Currency War?
A currency war is a ‘competitive devaluation’ of currency between a group of countries.
If the currency of any given country is devalued, then this means that their exports become cheaper for businesses in other countries to buy. This provides a boost to industry. At the same time imports from other countries become more expensive, forcing consumers to buy domestically produced goods and giving an additional boost to industry.
If the government of more than one country decide that they need to boost its domestic industry in this way, then a competitive downward spiral can emerge. Each new measure introduced in one country sparks reactive measures in the other countries who want their currency, and therefore their exports, to maintain their edge in relation to the others. This is what is known as a ‘currency war’.
Currency devaluation is not an entirely positive thing for a nation’s economy, however. In fact it is usually seen as a negative. This is because a devalued currency can reduce consumers’ spending power at home, and even more so if they travel abroad. It can also increase inflationary pressures.
In a currency war the negative aspects of devaluation are accentuated, because more and more extreme measures are needed to maintain the same advantages. Such situations can have a significant impact on global growth and economic stability.
Devaluation policies are usually pursued at times when unemployment is high and a country is struggle to stimulate domestic demand. At these times, and if inflation is not seen as an imminent problem, a government may try to stimulate growth through using devaluation to boost exports.
Risk Indicators for an Approaching Global Currency War
Clearly many countries around the world are currently experiencing high unemployment and are struggling to return to the levels of growth seen prior to the global financial crisis of 2009. Inflation is also relativey low in most countries around the world. This means that the conditions are ripe for currency wars to develop. But even beyond these general conditions, there are specific signs that a large scale breakout of competitive devaluation is brewing…