Are the Currency Wars Back On?

Brace yourselves, forex fellas! Another round of currency wars is starting, but economies no longer seem to be bent on gaining an advantage in trade this time. Central banks have been getting creative with monetary policy while some have even resorted to actual intervention in an effort to keep their local currencies weak.

“Currency war” and “trade imbalance” became buzzwords a few years back, as China has been accused of engineering yuan weakness in order to have an unfair advantage in trade. You see, local currency depreciation makes the country’s exports relatively cheaper, thereby boosting international demand for these products.

While this is definitely good news for the exporting economy, it is actually a beggar-thy-neighbor strategy since it winds up hurting demand for products from other countries. Think of it as Newton’s Third Law of Motion (For every action, there is an equal and opposite reaction) applied to forex price action, as currency weakness results to relative strength for its counterparts. This became such a huge issue in 2010 that the G20 saw the need to make a coordinated effort to rebalance the global economy.

Fast forward to the present, major central banks seem to be at it again, although a different economic issue is at the front and center of it all. This time, deflationary concerns have prompted policymakers to implement or consider measures to weaken their local currency.

Apart from growth issues that have led some central banks to revert to a more cautious stance, falling commodity prices and weak inflationary pressures seem to be good enough reasons to maintain an accommodative monetary policy. After all, the prospect of cutting interest rates or increasing money supply typically results to currency depreciation, which then boosts price levels. That’s because a weaker local currency translates to lower purchasing power, which means that you’d have to pay more units of that currency to get the same product.

The ECB already got the ball rolling with its monetary policy easing back in June, when Governor Draghi and his men decided to cut several interest rates and announce new targeted LTRO. They followed this up with another round of rate cuts in September and dropped hints on purchases of asset-backed securities, which many speculated would be the start of more quantitative easing. The RBNZ also made an effort to weaken the Kiwi, as it staged a secret currency intervention back in August.

Switzerland is also plagued with deflationary concerns, but the SNB has stopped short of actual intervention and has been sticking to jawboning for now. The RBA also seems to be taking the same approach, as Governor Stevens has repeatedly emphasized that the Australian dollar remains high by historical standards. Meanwhile, the BOJ is starting to join this jawboning bandwagon, as Governor Kuroda mentioned that they’d welcome a lower exchange rate to help Japan reach its inflation target.

Market analysts say that deflation is both a catalyst and by-product of weak economic performance. Downbeat growth prospects weigh on price levels, which then result to a slowdown in consumption and production, eventually dragging growth much lower. Once a country enters this cycle, it would make sense to try to exit before things get much worse, sometimes even at the expense of other economies.

The problem with dumping deflationary issues from one economy to another is that it winds up hurting global economic growth. Do you think the G20 should step in again before it’s too late?