Will the Export Economy Spark a Global Currency War?


In a fragile economy, every country wants to expand its exports, and low currency values can help make products cheaper to international buyers. Could countries' efforts to stay competitive be sparking a currency war?

Some signs of conflict have already popped up. For example, the U.S. is pushing China to allow the yuan to rise, with Congress scheduled to consider a measure that could lead to retaliation this week. Earlier this month, the Japanese government sold yen to lower that currency's value, drawing some international criticism.

Brazil, which has intervened heavily throughout September to stem the growing value of its currency, warned on Sept. 20 that it's considering even stronger action. And Mexico also has been buying foreign currency as its peso has appreciated, although it cited a desire to boost its reserves -- not depreciate its currency -- as its motivation.

With many currencies heading downward, the price of gold hit a record of more than $1,300 an ounce Friday, a sign that investors are seeking a safe haven.

"We're in an export economy, therefore, the incentive is to have the lowest currency possible to boost your exports," says Brian Kelly, president of Darien, Conn.-based investment adviser Kanundrum Capital. "So when times are tough like you're seeing in Japan, their incentive is to devalue their currency. The problem is not everyone can do it all at once."

Too Early to Call the Conflict a War?

Much of the latest maneuvering has involved Japan and China, which is Tokyo's largest trade partner. Because China's currency is closely linked to the dollar, when the dollar goes down against the yen, so does the Chinese yuan. China bought Japanese bonds, which helped force up the yen, Kelly says. Now that the Japanese have sold yen to buy dollars, the Chinese are selling dollars and diversifying into other currencies, he says.

But all that doesn't necessarily amount to the opening salvos of a full-blown war, says Mark Chandler, global head of currency strategy at Brown Brothers, Harriman in New York. "Economic warfare may be a little strong, but economics and politics are at an intersection here more than at any other time," he says. While a number of countries are competing in the currency markets in their national interests, "I don't think there is a beggar-thy-neighbor policy for exports," he adds.

After all, the Japanese are trying to stem the rise of the yen, not cause it to fall, says Chandler, who notes that the currency has climbed 25% against the dollar in the last two years. Chandler cites market rumors that Malaysia and Thailand, also big exporters, are intervening in the currency markets to slow the upward drift in their currencies. The Malaysian ringgit is the fastest growing Asian currency this year, up 10.66%, while the Thai baht has risen 8.73%.

One of the main causes of the rise of Asian currencies is that investors have been fleeing the U.S. stock market and heading for emerging markets like Taiwan, South Korea and India.

U.S. Turns Up the Heat on China

President Obama last week urged China to do more to allow the yuan to rise. The Chinese currency is up only 2.06% since Beijing pledged in June to allow it to float slowly upward. U.S. economists believe the yuan is undervalued by about 40%.

The U.S. is "disappointed that there had not been much movement" since China's promise, says Jeff Bader, Obama's Asia adviser. "This had consequences for the global economy and for the U.S. economy, and we look to see more rapid and a significant revaluation in the months to come."

On Sept. 24, the House Ways and Means Committee approved a bill that would allow China's currency advantage to be used in calculating a so-called "countervailing" duty on Chinese imports. The bill goes to the full Senate floor on Sept. 29.

Currency Devaluation Can Be Risky

Under a headline of "Patriot games and currency wars," a Financial Times editorial Friday said Chinese exporters benefit from " a huge state subsidy" in the form of Beijing's intervention in the currency markets. But it added that hitting China with retaliatory measures wouldn't be effective. As historians like to point out, the introduction of tariffs in the 1930s helped cause the worldwide Great Depression.

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Indeed, currency intervention can be tricky, Kelly says. Switzerland intervened heavily in the market last year to bring down the value of the Swiss franc and lost about $7 billion in the process, he says. In spite of the effort, the franc continued to rise against the euro. And in 1992, the U.K. spent billions of pounds in an unsuccessful attempt to boost the value of its currency.

The impact of currency value on trade flows is also hotly debated. As Chandler points out, the Chinese allowed their currency to appreciate 25% against the dollar between 2005 and 2008, and still their trade surplus was even bigger at the end than at the beginning. The cheap labor, more than the price of currency, kept Chinese exports attractive.

Says Chandler: "Boosting exports and having a weaker currency are not the same thing."