Will More Fed Easing Lead to Currency Wars?

  • Share
  • Read Later

Get ready for monetary easing 3.0. That was the takeaway from Fed chair Ben Bernanke’s speech in Minneapolis today. Bernanke didn’t indicate what form easing might take. But any of the options on offer are bound to tick off countries like Brazil and Switzerland, which are struggling to hold down the values of their currencies against the backdrop of easy Fed policy. The question is whether those aggravations will lead to so-called “currency wars” and drag down the global economy.

The threat of currency wars (that is, when countries around the world start competing to make their currency cheaper than everyone else’s as a way to boost trade) has been lingering for a while. But yesterday’s announcement by the Swiss National Bank that it was “prepared to buy foreign currency in unlimited quantities” to steady its currency value added fuel to the fire. Why? Because when big central banks like the Fed make moves that reduce the dollar’s value abroad, other safe haven currencies offering higher returns, like the Japanese yen and the Swiss franc, experience a surge in demand. When the central banks of those countries step in to lower their currency values (which protects their export industries), other countries competing on trade tend to follow suit. Emerging markets like Brazil, meanwhile, suffer from “hot money” inflows from Western investors in search of riskier deals. The phenomenon amps up market confusion and distorts the value of other assets like gold.

So is that where we’re headed? Some economists, like the Carnegie Endowment’s Uri Dadush, are less worried about the threat of full-blown currency wars now than they were a year or two ago. For one thing, the Fed seems more likely to lengthen the maturity of its existing bond holdings than to launch another round of controversial bond-buying, aka QE3, which may have a more muted effect. In China, rising inflation is keeping the value of the yuan in check, which reduces the chances of a U.S.-China currency showdown. And with the global economy slowing and investors pulling away from riskier bets, emerging markets are less likely to suffer from massive inflows of “hot money.”

(LIST: 25 People to Blame for the Financial Crisis)

Even if we did experience a bout of currency battles, ThinkProgress’s Matthew Yglesias thinks this could actually be a good thing. He argues foreign exchange battles would help correct the massive imbalances between saver and debtor countries that are holding down the global economy.

What happens [in a currency war] is that countries experience a higher inflation rate, unless they don’t want to experience a higher inflation in which case they simply fail to participate in the “war.” At the end of the “war” countries that are experiencing below-capacity output are making more stuff, and countries that are already producing at near their current capacity end up with more stuff. Basically, everybody wins.

The problem with this scenario is the bit in the middle, the part before “everybody wins.” A competitive devaluation game can turn into a trade war, whereby losing countries start slapping tariffs on imports and exports to punish countries deemed to be “manipulating” their currencies. Trade wars, of course, make stuff more expensive for everyone, and that’s just about the last thing global consumers – increasingly squeezed by rising unemployment and inflation – need. A better approach to rebalancing is for countries to coordinate their currency moves, which would keep angry politicians from hammering their thumbs with trade retaliations. Friday’s G7 meeting is the ideal forum for a currency pow wow, if policymakers can get past their fretting over the eurozone’s endless woes. Currency stability, it’s worth remembering, was one of the main reasons the G7 formed.

(MORE: Should the Eurozone Become a ‘United States of Europe’?)

Roya Wolverson is a writer for TIME. Find her on Twitter at @royawolverson. You can also continue the discussion on TIME’Facebook page and on Twitter at @TIME.

0 comments
Sort: Newest | Oldest