Currency Wars or Efficient Spillovers? A General Theory of International Policy Cooperation

currency wars 2016

This protectionist policy was aimed at increasing the prices of Chinese goods and therefore making them less attractive to U.S. buyers. The dollar surged in the years before the COVID-19 pandemic primarily because the U.S. was the first major nation to unwind its monetary stimulus program, after being the first one out of the gate to introduce QE. This improvement in the terms of trade generally translates into a lower current account deficit (or a greater current account surplus), higher employment, and faster growth in gross domestic product (GDP). Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator.

Does Currency Affect Trade Wars?

As an example, the drastic oil price drop between 2014 and 2016 caused a mini-recession. Investors flocked avatrade review to the dollar, which caused the dollar value to increase by 25%. That exerts downward pressure on the dollar by making it less attractive to hold. Between 2008 and 2014, the Federal Reserve kept the federal fund rate near zero, which increased credit and the money supply.

It is the world's largest economy and the U.S. dollar is the global reserve currency. The strong dollar increases the attractiveness of the U.S. as a destination for foreign direct investment (FDI) and foreign portfolio investment (FPI). The phenomenon is also known as "beggar thy neighbor," which is not a Shakespearean turn of phrase but a national monetary policy of competitive devaluation pursued to the detriment of other nations. The stimulative monetary policies that usually result in a weak currency also have a positive impact on the nation's capital and housing markets, which in turn boosts domestic consumption through the wealth effect. So far, China has argued that the fluctuation in the yuan's exchange rate is due to market forces. Chinese trade experts say further devaluation would be risky for China's own economy, suggesting the country will not push the yuan much lower.

For the last 11 years, China has kept its currency below a symbolic 7-to-1 ratio to the dollar — until last week. A country devalues its currency in order to decrease its trade deficit. The goods it imports become more expensive, so their sales decline in favor of domestic products. A currency devaluation, deliberate or not, can damage a nation's economy by causing inflation.

The currencies of countries that left gold relatively early (like Great Britain, in 1931) depreciated relative to the currencies of countries that stuck with gold longer (like France, which left gold in 1936).
Setser says there was a period when China did unequivocally qualify as a currency manipulator.
By the end of the year, as the value of the dollar fell, China allowed the yuan to rise.
This combination of export-led growth and increased domestic demand usually contributes to higher employment and faster economic growth.

Policy Divergence

Indeed, recent years have seen neither an increase in U.S. net exports nor any sustained depreciation of the dollar. In the current era of floating exchange rates, currency values are determined primarily by market forces. However, currency depreciation can be engineered by a nation's central bank through economic policies that have the effect of reducing the currency's value. A currency war is when a country's central bank uses expansionary monetary policies to deliberately lower the value of its national currency. In a currency war, nations devalue their currencies in order to make their own exports more attractive in markets abroad. By effectively lowering the cost of their exports, the country's products become more appealing to overseas buyers.

Impact on Other Countries

Competitive depreciation became a contentious issue during the Great Depression. During the 1930s, the international gold standard collapsed, but it did so in a staggered way, with countries abandoning the gold standard at different times. The currencies of countries that left gold relatively early (like Great Britain, in 1931) depreciated relative to the currencies of countries that stuck with gold longer (like France, which left gold in 1936). The economies of countries that left gold earlier were also seen to recover more quickly from the ravages of the Depression. Some economists of the period, such as Joan Robinson of the University of Cambridge, argued that the recovering countries were doing so primarily through “beggar-thy-neighbor” policies of undercutting other nations in export markets.

[2] Not all countries allow their exchange rates to be market-determined, but that is a policy choice they make. Fiscal policy (in either the easing country or its trading partners) Pepperstone Forex Broker provides an additional potential tool for offsetting the effects of changes in currency values on output and trade. If easier Fed policy hasn’t damaged the net exports or growth rates of trading partners, then why have foreign policymakers complained?

The U.S. Strong Dollar Policy

[1] In modern lingo, they were saying that depreciation was a zero sum game; gains for one country came only at the expense of other countries. A weak domestic currency makes a nation's exports more competitive in global markets while simultaneously making imports more expensive. Higher export volumes spur economic growth, while pricey imports have a similar effect because consumers opt for local alternatives to imported products. Another is quantitative easing (QE), in which a central bank buys large quantities of bonds or other assets in the markets.

The stock market becomes less expensive for foreign investors. Foreign direct investment increases as the country's businesses become relatively cheaper. Currency depreciation is not a panacea for all economic problems. The country's attempts to stave off its economic problems by devaluing the Brazilian real created hyperinflation and destroyed the nation's domestic economy. In a sense, analysts say, China has given in to monetary pressure largely resulting from U.S. tariffs.

currency wars 2016

Still, the U.S. complained but did not declare China to be a currency manipulator. The yen carries trade disappeared when the Federal Reserve dropped the federal funds rate (the interest rate banks charge each other for overnight loans) to zero. The problem is, other nations may respond by devaluing their own currencies or imposing tariffs and other barriers to trade. The U.S. dollar fell from its heady heights and remained lower. That was just one side effect of the coronavirus pandemic and the Fed's actions to increase the money supply in response to it. Nations devalue their currencies primarily to make their own exports more attractive on the world market.

A country's government can also influence the currency's value with expansionary fiscal policy. However, expansionary fiscal policies are mostly used for political reasons, not to engage in a currency war. While the U.S. implemented its strong dollar policy, the rest of the world largely pursued easier monetary policies. This divergence in monetary policy is the major reason why the dollar continued to appreciate across the board. This combination of export-led growth and increased domestic demand usually contributes to higher employment and faster economic growth.

A currency war is sometimes referred to by the less-threatening term "competitive devaluation." Explore the background and actions in the so-called currency wars, with this interactive guide looking at the economic and political basis of the key countries’ actions. It's unlikely the next currency war would create a crisis worse than that in 2008. Alarmists point to several indications that one is imminent.

Does the dollar’s status asymmetrically benefit the United States (that is, does the dollar provide the U.S. an “exorbitant privilege,” as it was labeled by French finance minister Valéry Giscard d’Estaing in 1965)? Does dollar dominance amplify the international effects of Fed policies, or confer special responsibilities on the U.S. central bank? I tackled all three critiques in the Mundell-Fleming lecture at the International Monetary Fund in November and have just posted an expanded, written version . In this post and two to follow I will discuss each of these issues, starting today with currency wars.

The dollar could collapse only if there were a viable alternative to its role as the world's reserve currency. This affects U.S. mortgage rates by keeping them down, making home loans more affordable. This is because Treasury notes directly impact mortgage interest rates.

Currency Wars or Efficient Spillovers? A General Theory of International Policy Cooperation

Does Currency Affect Trade Wars?

Policy Divergence

Impact on Other Countries

The U.S. Strong Dollar Policy

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