Currency wars erupt from time to time, usually during times of economic turmoil. They typically involve countries seeking to gain a competitive export advantage by depressing their currency. What is less common is a so-called reverse currency war. But it is possible that one of them is brewing, either as a result of deliberate policies or as a side effect of central bank measures to fight inflation. In particular, the sharp rise in the value of the dollar as the US Federal Reserve continues its most aggressive interest rate hikes in nearly 30 years poses challenges to currencies and central banks around the world.
What is a reverse currency war and who is fighting one?
1. What is a currency war?
If a country’s currency goes down against other currencies, it can help its economy. Its exports become cheaper compared to those of its competitors, which stimulates foreign demand, while rising import prices stimulate domestic consumption of more local products and services. And both support local producers. A series of competitive devaluations are thought to have worsened the Great Depression which began in 1929, with countries abandoning the gold standard then in effect to weaken their currencies. In the early years of this century, the United States and other rich countries complained that China was depressing the value of its currency, the yuan, to increase its exports. But the phrase “currency war” was not popularized until around 2010, when then-Brazilian finance minister Guido Mantega accused wealthier countries of devaluing their currencies to boost economies still under stress. shock of the financial crisis two years ago.
2. What is a reverse currency war?
A situation in which countries strive to make their currency stronger. Rather than stimulating growth, the purpose of such a measure is to help control inflation, since a stronger currency means that imports are relatively cheaper. Fed actions have boosted the US dollar, pushing the Bloomberg indicator of greenback strength up almost 7% this year. On the other hand, the euro – which is used by more than 300 million people in Europe – fell to its lowest level in five years against the greenback, while the pound sterling and the majority of other major currencies also fell.
3. Does a stronger currency really curb inflation?
The strength of the currency weighs on inflation, but its importance is both debatable and subject to change, depending on circumstances. The extent to which changes in the exchange rate affect underlying inflation – which excludes volatile factors like food and energy – is called the pass-through rate. In some previous episodes of dollar strength, this rate has been marginal. But some, like Citigroup Inc. chief economist Nathan Sheets, argue that it could be higher in times of high inflation. In 2020, when inflation was subdued, a 10% increase in the value of the dollar might have been expected to dampen increases in the consumer price index by only about half a point. . But at the current pace of inflation, which has been driven largely by rising commodity prices, pass-through coefficients could be more than double, approaching a full percentage point, said Sheets, who previously worked for the US Treasury and the federal government. Reserve.
4. What are central banks saying about this?
Most central banks seek to steer their economy through a combination of interest rate changes and balance sheet actions, and are generally reluctant to do or say anything that could be construed as an attempt to directly manage exchange rates. The US Treasury can (and has repeatedly done so) label certain trading partners as currency manipulators if it believes they are trying to gain an unfair advantage. The Fed, for its part, stresses that its goal in raising interest rates is to fight inflation by curbing demand rather than supporting the dollar. Fed Chairman Jerome Powell said the central bank’s commitment to price stability has boosted confidence in the dollar as a store of value. Yet while most of the Fed’s major global counterparts have historically tended to walk the same tightrope around currency issues, some are more vocal on the link between exchange rates and inflation.
A sign of how things have changed recently is that some central banks previously known to use direct foreign exchange intervention to weaken their currencies are now doing the opposite. The Swiss National Bank, which has historically acted in currency markets to weaken the franc, has let its currency strengthen this year and said in June it would consider selling foreign currency if it weakened excessively. “We let the franc appreciate,” SNB Chairman Thomas Jordan said in March. “This is one of the reasons why inflation in Switzerland is lower than in the euro zone or the United States.” The head of the European Central Bank, François Villeroy de Galhau, meanwhile said that a euro “too weak” would go against the objective of price stability of this monetary authority, and in the United Kingdom United, Catherine Mann of the Bank of England went even further, pointing out how a faster pace of tightening could support the pound.
6. Are there winners and losers?
Consumers in countries that have managed to rally their currencies are the big winners in a reverse currency war, with domestic prices being slightly tempered due to greater purchasing power. But there are many losers, including multinational corporations, export-dependent nations and emerging economies. American companies ranging from Salesforce Inc. to Costco Wholesale Corp. have raised complaints about the soaring dollar in recent earnings calls. In effect, a stronger greenback decreases the value of these companies’ foreign earnings when converted into dollars. It also makes their products less competitive as prices rise in local currency, reducing demand. For developing economies, there is a risk that a “currency mismatch”, which occurs when governments, companies or financial institutions have debts in US dollars but pay in a depreciating local currency, could put at financial risk.
7. Who’s not joining the party?
With a currency in a dive, Japan seems to be playing by the old rules of currency wars. Bank of Japan Governor Haruhiko Kuroda kept yields anchored to the floor in an effort to stimulate the economy. In the process, the yen fell precipitously, losing more than 15% this year against the US dollar – the biggest drop of any Group of 10 currency. In mid-June, before the last BOJ policy meeting , Kuroda changed his position slightly, signaling that the central bank was monitoring the currency, in a rare departure from the status quo of remaining silent on the country’s exchange rate. He admitted that the sharp drop in the yen was not beneficial for the country’s economy, although the bank did not change the policy parameters. And calls for monetary intervention have multiplied. Takehiko Nakao, the former head of foreign exchange policy at the Ministry of Finance, said “unilateral intervention should not be ruled out as a possibility” during an interview on Bloomberg TV on June 23.
(Adds Takehiko Nakao’s comments in the last paragraph.)
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