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The rising risk of a tit-for-tat currency war

Monetary officials as far afield as South Korea, Russia, Sweden, the Czech Republic and Indonesia have signalled their readiness to join the devaluation wave to safeguard their interests.

YUSUF AHMAD/REUTERS

An indirect currency war is rapidly escalating as worried politicians finger their exchange rates as a mounting impediment to faltering economic recoveries.

Policy makers from Japan and China to France and Brazil are turning up the volume of their political rhetoric as they look for culprits in a post-crisis era marked by slow or no economic growth and rising unemployment.

Devaluing currencies to boost competitiveness is an old standby, but one fraught with the risk of tit-for-tat retaliation that could end up doing serious damage to the players involved and derail the global recovery.

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Some analysts argue that open hostilities have already broken out, fuelled by Japan's determination to weaken its yen, a rapid rise in the euro and several other emerging market currencies, and long-simmering anger over China's management of its yuan.

Monetary officials as far afield as South Korea, Russia, Sweden, the Czech Republic and Indonesia have signalled their readiness to join the devaluation wave to safeguard their interests.

Bank of England Governor Mervyn King recently warned that currency wars could drive the still-recuperating global economy into reverse. "You can see, month by month, the addition to the number of countries who feel that active exchange rate management, always to push their exchange rate down, is growing."

But others say full-scale war has not yet erupted and is unlikely to do so, given the enormous risks involved.

"A currency war is very much overstated," said Dean Popplewell, director of currency analysis and research with Oanda in Toronto.

"It's certainly at the stage of sabre-rattling. But the fact of the matter is not everyone can simultaneously have a weaker currency," said David DeRosa, president of DeRosa Research & Trading Inc. in New York.

"It reflects a frustration with economic circumstances around the world. We're in a period of malaise and these governments are at their wits' end trying to figure out how they can raise growth and avoid their own fiscal crises. So they look around and settle on the exchange rate."

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But apart from China, all of the main players have floating exchange rates that largely reflect market conditions. Government and central bank policies can try to steer rates in one direction or another, for instance, by controlling inflation.

That appears to be behind French President François Hollande's pointed remarks to the European Parliament this week, declaring in advance of a crucial European Central Bank policy meeting Thursday that the euro zone needs "a foreign-exchange policy. Otherwise, it has an exchange rate imposed on it that does not correspond to the real state of the economy." What he really wants, analysts suggest, is for the ECB to inject a dose of inflation to weaken the euro and ease his government's fiscal woes.

Faced with insufficient growth, politicians see a weaker currency "as a direct shot at improving their export competitive status," Dr. DeRosa said. "All of this is very questionable economics. It's also very questionable that a central bank would try to do any of these things."

But they intervene in the markets at their peril. The political rhetoric makes it seem as if the exchange rate is just "an inconvenient fact, when the truth is that exchange rates are market prices. They clear markets and they have implications for the allocation of resources and the distribution of goods. They are trying to achieve a political motive [lowering exchange rate, boosting inflation] and they think that these are magic policy dials that the central bank can set," Dr. DeRosa said.

The unwanted result is typically "a misallocation of resources when a government or central bank starts fooling around with market expectations."

What central banks are more likely to do is intervene to reduce the pace of acceleration or deceleration of their currencies, analysts said. Less likely is a Brazilian-style effort to stem the rise of the real by imposing taxes to curb certain types of investments and then reversing course to try to prevent too quick a descent.

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"A race to the bottom does nobody any good," Mr. Popplewell said. "If it's overdone, it provides no growth whatsoever."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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