Currency war: It appears that remains more of a potential risk than a reality – Charles Schwab

 Jeffrey Kleintop, Senior Vice President, Chief Global Investment Strategist at Charles Schwab points out that despite many rate cut around the world during 2019 there has been relatively little currency movement by developed or emerging market currencies. He adds that if rate cuts aren’t seen as enough to address slowing growth and policymakers turn to direct currency intervention, the resulting currency war could be bad news for investors.

Key Quotes: 

“In a tariff war, the U.S. has a big advantage over China due to the trade balance. But, in a currency war, China has way more ammunition than the U.S.”

“China’s currency may continue to depreciate against the dollar, barring a halt to the tariffs. That is because the Chinese currency had been stronger than market forces would indicate lately thanks to the Chinese government trying to keep the yuan from falling by fixing an exchange rate higher than market implied values in order to facilitate trade talks with the United States. But this month, China has let the yuan slide about 2%--almost all in one day, as you can see in the chart below--when trade negotiations broke down and Trump announced a new 10% tariff on $300 billion worth of imports.”

“If rate cuts aren’t seen as enough to address slowing growth and policymakers turn to direct currency intervention, the resulting currency war could be bad news for investors. Fighting economic weakness with a lower currency exports disinflation, reducing growth rates. While inflation erodes the value of debt over time, deflation does the opposite and the world has seen rapid debt growth in recent years.”

“Might we still see a currency war? Perhaps, but it’s a zero sum game—devaluing currency to boost exports and lift inflation is at the expense of trading partners and encourages them to do the same. There could be a race to do it first, which might give policymakers a short-term crutch, allowing them to avoid having to make longer-term structural changes that could be politically costly. We will continue to monitor these developments to see if the tariff war shows signs of turning into a currency war. But, for now, it appears that a currency war remains more of a potential risk than a reality.”