General Financial News
The global 'currency war'
Oct 21, 2010 03:55 PM
There are shades of the 1930 Smoot-Hawley Tariff in today's debate over the global "currency war," as Brazilian finance minister Guido Mantega referred to the current state of affairs.
The tariff, a protectionist measure that levied taxes on foreign imports, is often credited with setting off a round of retaliatory measures and exacerbating the impact of The Great Depression. While the parallels aren't all in place - the current phase of neo-mercantilist policies is taking place in the wake of the collapse, instead of front-running it - there are compelling reasons to consider the effects of central banks manipulating currency for national gain.
The idea behind floating exchange rates is that the free market will adjust the relative value of currencies to match their situation.
The U.S. has slammed its interest rates to zero and is, by all appearances, ready to conduct another massive, money-printing expansion of the Federal Reserve balance sheet. That puts significant downward pressure on the U.S. dollar - which in turn should boost the price of commodities that are priced in dollars.
But a weaker dollar means that U.S. consumers will buy fewer imported goods - and export-heavy manufacturers like Japan and China suffer as a result.
The Bank of Japan has been trying to keep the value of the yen down, but as anyone with a dollar-yen currency futures chart can tell, it's powerless against the might of Ben Bernanke's printing presses.
China's a somewhat different story, as its tight currency control regime allows it to peg the renminbi to the dollar. By keeping its currency artificially cheap, it prioritizes its export industries to the detriment of American workers, who can't compete, and its own consumers, who are able to buy less with their cash.
Dominique Strauss-Kahn, the managing director of the International Monetary Fund, has spoken out against this trend, and called for a return to the cooperation that characterized international leadership and central bankers directly after the credit crisis.
"Today, there is a risk that the single chorus that tamed the financial crisis will dissolve into a cacophony of discordant voices, as countries increasingly go it alone," he said during a speech in Shanghai this week. "This will surely make everybody worse off."
Falling currencies tend to raise the nominal price of currency futures - but there are some complex effects that come into play.
Crude oil futures, priced in dollars, pose an interesting question. If the dollar continues to lose value, oil-exporting nations like Venezuela, Saudi Arabia and Iran will see their revenues decrease, because the dollars they receive are worth less. For several years now, there has been talk about transitioning the petroleum trade into a basket of currencies.
That would strike a blow at the U.S. dollar's role as a reserve currency, which would probably result in a further downward spiral for the dollar and more economic chaos.
At the same time, if a global currency battle erupts, investors may continue fleeing to assets that are seen as safe - like dollars and treasury bonds. When China raised interest rates, the markets reacted by bailing out of stocks, other currencies and commodities.
It's a tricky balance to play - and if nations start engaging in neo-mercantilist currency wars, it's only going to get trickier.
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