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Until now, most experts have been reluctant to use the term “currency war” to describe this year’s global arms race in foreign exchange markets. But China certainly fired a big shot over the bow this week.
By formally cutting the government-managed value of the yuan, China raised the trend of increasingly competitive currency devaluations to a new level. In a world where struggling economies have been adopting policies that have driven their currencies lower in not particularly transparent attempts to stimulate export growth (30 central banks have cut interest rates this year), the world’s biggest exporter went to a new extreme to defend its turf.
Other export countries – including Canada, which has cut rates twice since January and is banking on an export recovery to revive its flagging economy – will surely feel the heat. So will the global financial markets, which look more fragile with every new volley in the currency battle.
There’s no reason to think all this will end well. About the best we can hope for is that it will all prove pointless.
Let’s consider how this is going to work. If everyone drives their currency down, then no one is gaining the desired big export advantage, at least not for any significant time. Basically, nobody wins.
At the same time, currency wars fuel financial market volatility. Devaluations sap buying power from domestic consumers. They discourage consumption and investment. They spark international trade feuds. Ultimately, currency wars hurt global growth.
Of course, individual countries are wrapped up in their own problems and aren’t easily convinced, at a time when their domestic economies are stagnating, that a low-currency policy isn’t the best medicine to uncover the demand they so desperately seek. The logic that leads to a currency war seems to be the naive expectation that your country can act in isolation, that everyone else isn’t thinking the same thing. That is, until everyone else clearly is.
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