What Is a Currency War?

Thank the Global Currency War for Lower Prices

currency war
Currency wars can lower the value of all currencies. Photo: Enis Aksoy/Getty Images

Definition: A currency war is when a nation's central bank uses expansionary monetary policy to lower the value of its money. Low currency values aid exports by making them cheaper in comparison to other countries' exports. That helps businesses and boosts economic growth. It also makes imports more expensive. That hurts consumers and adds to inflation. 

Currency wars is a term coined in 2010 by Brazil's Finance Minister Guido Mantega.

He was describing the competition between the United States and China to have the lowest currency value.

How It Works

Exchange rates determine the value of one country's currency versus another's. A country in a currency war deliberately lowers that value. Countries with fixed exchange rates just make an announcement. Most countries fix them to the U.S. dollar because it's the global reserve currency

Most countries are on a flexible exchange rate. They must increase the money supply to lower the currency's value. A central bank has many tools to increase the money supply by expanding credit. It can lower interest rates. It can also just add credit to a nation's bank reserves. That's called open market operations or Quantitative Easing

A country's government can also influence the currency's value. It does this by spending more or cutting taxes (expansionary fiscal policy.) Usually, it does it for political reasons, not to engage in a currency war.

 

United States Currency War

The United States allows its currency, the dollar, to devalue. It uses expansionary fiscal and monetary policy. Federal deficit spending increases the debt. That exerts downward pressure on the dollar by making it less attractive to hold. The Federal Reserve has kept the Fed funds rate near zero since 2008.

That increases credit and the money supply. When supply outweighs demand, the value of the dollar drops. 

These aren't normal times. Since the financial crisis, the dollar has retained its value despite expansionary policies. That's because it is the world's reserve currency. Investors buy it during uncertain economic times as a safe haven. As a result, the dollar strengthened 25% between 2014 and 2016

China Currency War

China manages the value of its currency, the yuan. The People's Bank of China (PBOC) loosely pegs it to the dollar, along with a basket of other currencies. That means it kept the yuan within a 2% trading range of around 6.25 yuan per dollar. 

On August 11, 2015, it startled foreign exchange markets by allowing the yuan to fall to 6.3845 yuan per dollar. For more, see Yuan to Dollar Conversion.

Japan's Currency War

Japan stepped onto the currency battlefield in September 2010. That's when Japan's government sold holdings of its currency, the yen, for the first time in six years. The exchange rate value of the yen rose to its highest level since 1995. That threatens the Japanese economy, which relies heavily on exports. A high yen value makes those exports cost more in the U.S. and other countries.

It reduces demand and slowing Japan's economic growth.

Japan's yen value had been rising because foreign governments have been loading up on the relatively safe currency.  They moved out of the euro in anticipation of further depreciation from the Greek debt crisis. They left the dollar because of unsustainable U.S. debt.

Most analysts agreed that the yen would continue rising, despite the government's program. That's because of forex trading, not supply and demand. It has more influence on the value of the yen, dollar or euro. Japan can flood the market with yen all it wants, but if forex traders can make a profit from a rising yen, they will keep bidding it up.

Forex traders created the opposite problem for Japan ten years ago, creating the yen carry trade. They borrowed the yen at a 0% interest rate.

They invested in the U.S. dollar which had a higher interest rate. The yen carry trade disappeared when the Federal Reserve dropped the Fed funds rate to zero.

European Union

The European Union entered the currency wars in 2013, to boost its exports and fight deflation. The European Central Bank (ECB) lowered its rate to .25% on November 7, 2013. That drove the euro to dollar conversion rate to $1.3366.

Impact on Other Countries

These wars drive the currencies higher of Brazil and other emerging market countries. It raises the prices of commodities. Oil, copper, and iron are these countries' primary exports. That makes emerging market countries less competitive and slows their economies. 

In fact, India's former central bank governor, Raghuram Rajan, criticized the United States and others involved in currency wars. They export their inflation to the emerging market economies. Rajan had to raise India's prime rate to combat its inflation, risking slower economic growth. For more, see India's Economy.

How It Affects You

One of the world's richest men is Mexican telecom titan Carlos Slim​. He said that the currency wars between the United States and China result in higher food prices. (Source: "Slim Says Currency War May Mean ‘Excessive’ Commodities Prices," Bloomberg, October 20, 2010.)

As the value of the dollar declines relative to other currencies, the prices of imports will rise. We have already seen an increase in food and oil prices. It also lowers the price of U.S. exports, which helps economic growth. It also makes the U.S. stock market a good deal. China's Treasuries purchases keep U.S. mortgage interest rates affordable.  For an explanation of this, see Relationship Between Treasury Notes and Mortgage Interest Rates