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Currency war: Overflowing dollar against other currencies

By Shi Jiaqi (chinadaily.com.cn)
Updated: 2010-10-26 11:25

The phrase "currency war" has been making headlines around the world in recent months. Unlike the "trade war," which has raised universal concerns since the onset of the international financial crisis but has not been seriously dealt with at the G20 summits, the currency war will rank among the top priorities at the impending Seoul summit.

Will the world leaders reach consensus on how to prevent this issue from developing into a full-fledged war? Well, it's still too early to tell. What is certain is that most of the involved countries blame America for worsening the situation. By sending the message that it will launch a second round of "quantitative easing," it actually starts a war on three fronts.

The first front of the war: the fight between the dollar and the currencies of other developed economies.

Obviously, that America will further loosen its monetary policy is not good news to the euro zone. The EU has just recovered from the sovereign debt crisis, which culminated this May in the form of the Greek crisis, and is in no mood to follow America's suit. On the contrary, it plans to remain on a tight fiscal track and even talks about withdrawing liquidity from the markets.

This divergence of policies can be partly explained by the different primary goals pursued by the two economies. While the US put employment and economic growth before all other issues, what the EU cherishes most is low inflation, stability, and, of course, viability of the euro. America's decision will undoubtedly strengthen the euro against the dollar, which, if not handled properly, will further dim Europe's economic prospect. That's why Steffen Seibert, spokesman for the German chancellor, angrily said, "One could of course also argue that the US currency might not be fully at its real value, given the ample amount of liquidity that's being pumped into the markets, which tends to devalue the dollar."

Unlike the war between the dollar and the euro, the battle between Japan and America takes another form. From September 2008 to this September, the yen had appreciated 29 percent against the dollar, which adversely impacted its export sectors. Days ago, Japan criticized South Korea's currency intervention, accusing the latter, by keeping the won low, of gaining an edge in pricing and profit margins in export industries that the two countries compete in.

To reverse this trend, Japan spent $25 billion to intervene in the exchange rate markets in September. The last time the Japanese central bank intervened on a large scale was six years ago. When the Fed was still debating on the next move, Japan made up its mind to ease its monetary policy. For Japan, the most important thing is to curb the yen from further appreciation. The way to do that is to join in the money-printing race started by the US. The second front of the war: the fight between the dollar and the currencies of the emerging markets. After the outbreak of the financial crisis, world leaders' decision to collectively adopt the accommodative monetary policy turned the international liquidity from rare to ample.

However, the persistent high unemployment rate and the uncertain economic outlook are driving the money from developed countries to emerging economies. The latter, with rare exceptions, have witnessed a surge of capital inflows and a steady appreciation of their currencies.

Brazil's real, for example, appreciated against the dollar by 30 percent last year, and more than 5 percent this year. Other emerging markets' currencies, from India's rupee to those in the East Asian economies, have also seen a rise ranging from 5 percent to 10 percent.

Many emerging economies have come under dual pressures. Externally, the steady appreciation of their currencies threatens to weaken their exports. Internally, the constant and huge capital inflows exacerbate inflation and asset market bubbles. That's why the US decision of further easing gets on their nerves. As angrily pointed out by Brazil's president Lula, "There is a currency war on … All currencies are appreciating against the US dollar because the US needs to find a way to recover its economy."

To prevent further appreciation, some of the emerging markets have already intervened heavily in the exchange rate markets, some deciding to impose or raise taxes on foreign capital. For example, invested on their national debt, others are planning to intervene when they deem it necessary. All of them are looking to the G20, hoping a kind of international regime can be invented at the Seoul summit to tame the volatile capital inflows.