So far most governments have been taking Japanese efforts to devalue their currency in stride. With the yen sliding to unprecedented lows, however, the Obama administration has warned the Japanese not to hold down the value of the yen through artificial means. Meanwhile the U.S. Treasury has slammed China for holding down the value of its currency. Could the increasing rhetoric point to a future currency war?
Some countries try to deflate the value of their currencies in order to make their exports cheaper. When a currency declines in value, goods produced within the nation become cheaper for foreigners to purchase. A devalued currency can give a country major advantages in terms of trade and in theory should boost domestic growth. Both China and Japan deny that they are artificially holding down the value of their currencies, however there is plenty of evidence to the contrary.
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While the Japanese claim that their economic polices are not aimed at devaluing their currencies, actions speak louder than words. Since Prime Minister Abe took office, the Japanese yen has devalued 15% against the U.S. dollar. In the last few weeks alone, the yen has dropped 7 percent against the dollar amid a massive effort by the Bank of Japan to increase the money supply. Using quantitative easing, the BOJ has bought up huge amounts of bonds and other assets. Japanese officials claim that the drop in the yen is a by-product of efforts to stimulate the economy.
The Japanese are also pushing for increased free trade with the United States and other Pacific nations. And why not? With a massively devalued currency, Japan will have distinct trade advantages over anyone they engage in free trade with.
Meanwhile, the U.S. Treasury Department blasted China in its semi-annual report, claiming that the nation is holding back the value of its currency. China allows the renminbi only to trade within a narrow trade band. While the government has been working to slowly increase the value of its currency, many analysts and governments have criticized the moves as too slow and are calling for the renminbi to be traded on the free market.
Some analysts believe that the renminbi could be devalued by as much as 25 percent. If so, this would give China a massive advantage in international trade and would go a long way in explaining the USA’s massive trade deficits with the nation. In February of 2013 alone, the USA’s trade deficit totaled more than 23 billion dollars.
Of course, other countries have already accused the U.S. of trying to devalue its own currency through quantitative easing efforts. While the government claims that these efforts are to increase liquidity and lending, some suspect that the true goal is to deflate the U.S. dollar and increase exports. In fact, Bloomberg reports that the U.S. Fed plans to reduce the value of the dollar by 33 percent over the next 20 years.
If the U.S., China, and Japan all continue to deflate the value of their currencies, the risk of other countries responding with their own devaluations will increase. Before currencies were floated in markets and were pegged to gold and silver, the world saw numerous currency wars sparked by devaluations. Most of these currency wars resulted in recessions and depressions. Indeed, evidence suggests that devaluations contributed to the Great Depression, prolonging and worsening it.
With the global economy so weak, a major currency war could derail growth in Asia, and send the United States and European Union spiraling into deep recessions. Still, with populist pressures to provide jobs, the possibility of boosting exports through devaluations must be tempting for many public managers. While no major currency war has occurred in the last several decades, global conditions have now made such an event more likely than ever before.
One thing is certain, the last thing the global economy needs right now is a currency war.