Since Germany left the gold standard in 1931, finance ministers have fought a cold war in currency exchanges to artificially bolster their economies. In the age of Trump, there is no knowing where or when the next bout will begin.
Currency wars have been a venue for economic nationalism since long before U.S. Treasury Secretary John Connally challenged foreign finance leaders in 1971 with the memorable line, “The dollar is our currency, but it’s your problem.” Germany was the first modern government to artificially devalue its currency to gain an advantage in international trade. Back in 1931, the country was suffocating under harsh reparations stipulated by the Paris Peace Conference at the end of the First World War, and many of its creditors—starting with the United Kingdom—soon followed suit and abandoned the gold standard.
In the following decades, dozens of nations left the gold standard, and central banks intervened in the currency market countless times. So, while many know that the treaty that ended WWI laid the foundation for the next global conflict, most do not realize that it also drove the creation of a new international (dis)order in finance. Today, advanced economies are in the midst of a currency cold war, but it is the developing world that is caught in no-man’s land.
NO ONE IS INNOCENT …
Donald Trump made big news during his 2016 presidential campaign by complaining about China’s currency manipulation. It is true that, over the years, China’s central bank has rarely had a hands-off approach on both the domestic and international levels. Pretending that currency manipulation is a phenomenon found only in totalitarian regimes is a fantasy, not unlike the Paris Conference’s infamous War Guilt Clause. Like it or not, every world power has dirty hands.
The actions of the United States since the Great Recession provide a prime example of currency manipulation. Following the example of German politicians after World War I, the Fed sought to create a “soft landing” for the economic recession. This took the form of an expansionary monetary policy that included the manipulation of interest rates and quantitative easing, both of which resulted in a lower valuation for the dollar. Other advanced economies quickly followed suit.
Today, the biggest players in the currency wars are economies like the United States, China, Japan, the European Union, and Russia. Politicians and bankers from Washington to Moscow take turns instituting weak currency policies. Since every country cannot devalue its currency simultaneously to gain by the move, a tit-for-tat system of “cooperative competition” now stands in the place of a traditional market. China orchestrated a weak yuan in 2009, the United States devalued the dollar in 2011, Abenomics took down the yen in 2012, and in 2014, the European Central Bank (ECB) injected the market with a mixture of negative interest rates and quantitative easing. All this to replace that old-fashioned understanding of a healthy economy—growth.
As of May 2017, China has apparently unofficially pegged the yuan to the U.S. dollar, which has driven down expectations of volatility to a two-year low. Yet experts warn that a resurgent dollar could do serious damage to China’s economy.
… BUT SOME WIN, SOME LOSE
The term “currency war” entered the public eye following a 2010 statement by Brazilian finance minister Guido Mantega. “We’re in the midst of an international currency war, a general weakening of currency,” he said. “This threatens us because it takes away our competitiveness.” As an emerging economy with a high export-to-GDP ratio, Brazil sits directly in the line of fire when an advanced economy devalues its currency. And it is not all talk—recent analyses confirm that fiscal policies in developed countries have far-reaching effects on emerging economies.
It is worth bearing in mind that currency appreciation and devaluation are normal—even healthy—parts of a normally operating exchange. When currencies “float” in the market instead of being pegged to gold, or at least to another (relatively stable) currency, moderate increases in value are appropriate when the economy of the nation in question grows. Without some fluctuation, the exchange market would not really be a market, but simply a list of prices. It is abrupt change that can have a devastating impact on an economy. The famous East Asian crisis that tore through Thailand, Indonesia, and neighboring nations in 1997–98 was in large part a reaction to the sudden depreciation of the Thai baht. During the panic, Thailand saw its GDP drop more than 10 percent in one year and was forced to accept International Monetary Fund (IMF) funds and strict new limitations on its fiscal policy as a result.
While currency wars may lead to sharp depreciations if they trigger a “twin crisis,” or an economic downturn that results in a full-blown currency implosion, most people in Guido Mantega’s shoes fear a subtle deterioration of growth. On the flip side, “successful” currency manipulation can result in short-term gain for the manipulator.
In its charter, the IMF affirms that no nation should “manipulate exchange rates … to gain an unfair competitive advantage over other members.” Today, several currencies are designated as “undervalued” by the IMF. One such currency is the Korean won. South Korea has surged into its role as a tech and manufacturing powerhouse over recent decades, but its currency has grown a bit slower than some might expect it to. Even so, the country’s businesses are starting to lose their competitiveness as the won appreciates. Perhaps it is not surprising, then, that the nation has a history of asymmetric foreign exchange interventions and that it does not make these interventions public.
The U.S. Treasury has a monitoring list specifically geared toward currency manipulation in countries such as China, Japan, Korea, Taiwan, Germany, and Switzerland. It is safe to say, however, that the Fed has landed the United States on similar lists around the world.
THE UNCERTAINTIES OF TRUMP
Candidate Trump promised to have China labeled as a currency manipulator. Yet by the third month of his administration, President Trump had changed his mind, perhaps taking the China has not manipulated its currency since mid-2014, when it began selling off currency from its reserves. This about-face is just one example of the issues that experts face when predicting the future of international currency exchanges in the age of Trump. They also underscore the geopolitical ramifications of what was once a purely economic calculation.
Surprisingly enough, Trump’s biggest impact on international currency markets thus far has nothing to do with China. Instead, the president has pointed his finger at Germany. According to CLS Bank International, the biggest foreign exchange services company in the world, currency volumes were most affected by politics on January 31, 2017. That day saw a US$215 billion deviation from the 2016 average because U.S. trade advisor Peter Navarro claimed that Germany utilized a “grossly undervalued” euro to its own advantage. German Chancellor Angela Merkel responded that as a part of the eurozone, Germany does not have the ability to manipulate the euro. In April the U.S. Treasury put Germany on its watch list—stopping short of naming it a currency manipulator.
Germany’s case may attract some attention over the coming months. In the assessment of the U.S. Treasury, Germany benefits from a euro weakened by the economic crisis in Greece. While wages and environmental standards in Germany remain high, the currency remains low, resulting in a hefty trade surplus with the United States (around US$65 billion).
A COOLING OF TENSIONS
Official voices predict a general cooling in the currency manipulation climate for the next few years. According to analyses of the most recent G20 meeting, even longtime currency manipulators have agreed to allow the situation to stabilize for the time being. In recent months, the Bank of Japan and the ECB have begun easing off intervention and letting the market price settle, albeit gradually. So it seems that while many countries remain skeptical of extended cooperation, short-term competition may not be as cutthroat as it has been in recent years. Yet in these uncertain times, no one knows just how long this cooling will last until economic or geopolitical pressures pit finance ministers against each other once again.
