A currency war

Could we see a currency war in the world?

Will there be a currency war? That was the trending question on Twitter the day after China devalued the Yuan by 2%. To be fair, a currency war began in 2010 when countries like Japan and the EU adopted a loose money policy. The idea was to debase their currencies so that exports increased. Ironically, 2010 was also the year when the US had announced plans to double exports by 2015. But other countries debasing currencies and China debasing its currency are entirely different. First, the history of currency wars!

Currency War – Round 3

The first currency war began in 1921 when Germany began to devalue the Mark to push up its exports. In fact, this devaluation was a silent attempt by the Germans to counter the harsh conditions of the Versailles Treaty. As other nations joined this devaluation game, Germany’s mark debased to a point where people had to carry money in trucks and buy goods in hand bags. The resulting hyper-inflation led to the rise of Hitler and to World War II.

The next round of devaluations began with the Pound Sterling in 1967 trying to improve its competitiveness versus the US. Eventually, this led to a currency war and Richard Nixon abandoning the gold standard. The third round was started by loose-money policies but may now gather momentum with the arrival of China in the currency war.
Why China is so pivotal…

In terms of economic might, China is akin to what the UK was in the mid-60s. China is already the world’s second largest economy with a GDP in excess of $10 trillion. It is also the world’s largest exporter and the biggest importer of commodities. The US alone runs a trade deficit of $235 billion with China. Most commodity-driven exporters like Brazil, South Africa, Australia, Indonesia and Malaysia depend heavily on Chinese imports. These currencies have already depreciated substantially since the sharp fall in commodity prices started. Yuan devaluation will only force these currencies further down.

EU is the biggest export market for China (much larger than the US) and a strong Euro will perfectly suit China. In fact, China’s participation may actually convert this into a global currency war.

A Chinese devaluation will force the commodity exporters to follow suit. We are already seeing that with South Africa, Indonesia, Malaysia, Kazakhstan, Australia and Turkey. China may be largely indifferent to a strong US dollar due to its $3.5 trillion currency stash. And that is the worry for the US. The Fed decision on rates may also predicate on this factor. The bottom-line is that slow growth and weak commodity prices may have just started off a currency war. For China it may be back to exporting goods and some deflation! ©

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