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Fighting the Currency War

Apr 14th 2011 at 2:28 AM

The urge for superiority is human nature, and the most obvious proof of this is global domination through war. Weapons of war such as jet fighters, bombers, tanks, warships, and missiles are effectively used to annihilate enemy forces to gain—and prove—one nation’s supremacy.

However, much of the world abhors such acts of violence and devastation. Thus, today, the new battlefield is in the financial sector. The 21st century will be fought by currency, and the embers are starting to glow. Who will win? Will it be the Dollar, Yuan, Euro, or some other currency? The world’s major currencies are fighting an invisible war, a war that involves politics, businesses, central banks, and governments worldwide. Unlike the Cold War where nuclear weapons were the armaments that make the world tremble, today, money is the ultimate weapon of mass destruction in this masqueraded battlefield. It is currency that enforces the demands with the governments around the world, their leverage to position themselves to power, consolidate, and expand. The currency war was theorized and explained in detail by Daniel D. Eckhert in his military-styled book “War of the World Currencies—How to Fight Euro, Gold, and Yuan, the Legacy of the Dollar.”

Over the past decades, the players of this battle have been informally divided into “deficit” and “surplus” countries. Deficit countries such as the UK and the US borrow money from other countries so they can import more than they can export. Surplus countries such as Japan, China, and other Asian countries lend money to other countries to help finance their exports. The Euro has been exporting as much as it is importing, roughly staying in the balance, although there are also big imbalances in its member countries: Germany has a huge surplus, while Spain and Greece are running deficits, threatening national bankruptcy.

During the 2007-to-present financial crisis and global recession, imports by the deficit nations and exports from surplus countries momentarily collapsed. When the economy recovered, latest trade data has shown that after the recovery, the imbalances have started to show themselves.

This phenomenon has generated volatile tensions waiting to explode. The US and UK says it wants to export more products to help recover its economy. China and Japan is withholding that opportunity, not wanting to lose their competitive advantage. Thus, the fastest way to gain a competitive advantage is by introducing a weaker currency. With the global recovery still so weak, a large number of exporters in countries around the world are suffering from the effects of their currencies that are increasingly become stronger against the dollar.

Unfastening the Linchpin

Most currencies fell against the US Dollar during the recent financial crisis. Thus, investors, believing that the dollar was safe haven, bought quantities of the currency. But now, since most currencies are steadily rising against the US Dollar again as worldwide economy is recovering, US interest rates are going near zero, and the country is mired in a weak recover, making the dollar less attractive.

China, meanwhile, has pegged the Yuan to the dollar in 2007 and is stuck with the peg during the crisis. In order to keep its currency weak against the dollar, the People’s Bank of China bought trillions of the latter currency. Naturally, the US was not happy about it and has spread word that the move was to help keep Chinese exports artificially cheap. Critics complained that even if China is performing well in economical terms, the country possesses a huge trade surplus while other countries in the world, especially the US, remains relatively economically weak.

Last June 2010, China cut some slack off the peg a bit after months of pressuring by the US. However, the US government says the peg level is inadequate. In response, the Chinese said that unlike other exporting nations, they did not let the Yuan depreciate against the dollar during the financial crisis.

However, the Chinese believe that if they increase the value of their currency too quickly, the change will rapidly bankrupt many of its export companies and destabilize their economy.

The US sees China as an anchor—if it can persuade Beijing to strengthen its currency, other smaller exporter nations may follow and strengthen their own currencies.

The Rising Yen

Decades ago, the Japanese yen was weak thanks to the country’s zero interest rates. It was a cheap currency for speculators to comfortably borrow in and sell. Today, however, the currencies of UK, US, and the European Union have near-zero interest too, which unsurprisingly is taking away the Yen’s competitive advantage. Since the 2008 crisis, the Yen has been rising steadily, hurting Japanese exporters and pushing the nation back towards recession.

The Japanese intervened to weaken their currency September last year. The move caused aggravation after China suggested that they might start buying Yen instead of dollars. Also, the weakening was short-lived, and the Yen is again strengthening against the dollar.

Alternatives to the War

The war of these major currencies leaves a big question—what can the US and UK do to lessen their deficits?

One option is implementing strict credit guidelines. The effect of the financial crisis left consumers and companies reducing their borrowing. If government of any of the deficit countries does the same, the deficit may go down. However, if the noose is too tight, extreme austerity may cause a recession, especially if the surplus keeps on lending.

Another option may be looser money. However, with the interest rates at or near-zero, central banks are forced to quantitative easing, which is printing money and injecting it to the economy to buy up debts or intervening directly in currency markets.

US Congress is hoping of another radical option that Washington might consider—imposing trade sanctions against China. However, just like in any war, the aftermath can be devastating. Experts fear that imposing a trade sanction raises the specter of protectionism—protectionism started by the US that led to a collapse of trade that resulted to the Great Depression of the 30s.

Let’s see what will happen this time – what do you think?

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