WASHINGTON, D.C., February 16, 2013 ― The currency war, which has been going on for a couple years, is about to go nuclear.
What is a currency war? It is a last-ditch effort to save the economy of a nation that is stuck in rut of stagnation, such as the U.S., or even worse, trapped in deflation, as Japan has been for quite some time.
The artillery used in a currency war is currency devaluation. The casualties are the citizens, particularly those living on fixed incomes. The only possible winners are people at the top whoe receive the new money as it come off the presses, since they will be able to buy hard assets with the newly created currency before anyone knows the currency is worthless.
A currency war is a beggar-thy-neighbor strategy. It is formally known as competitive devaluation, a race to the bottom to get lower and lower exchange rates. As the price of a country’s currency falls, so to does the real price of its exports, while at the same time import prices rise.
This strategy is a way to “encourage” domestic firms, such as Apple, to manufacture their products in the US instead of lower cost countries like China. This boosts domestic industry, both at home ‒ as industries return home and employment rises ‒ and internationally ‒ as the prices of goods sold abroad fall relative to the prices of goods produced in countries not involved in the war. This is why no country stays out of a currency war once it begins. It is a recession in a bottle you can counter with the push of a button; you would be crazy not to join the fray.
The obvious risk in this war is runaway inflation, as expanding your country’s money supply alters the supply and demand equation profoundly. Currency, just like a can of beans or a pound of copper, is a commodity. The only difference is that the can of beans maintains its real value better. As you see the price of the can of beans go up or down, that reflects the value of the currency, not the value of the beans.
The new Prime Minister of Japan, Shinzo Abe, took office on December 26, 2012. Since that time, the Japanese yen has been devalued by 20 percent. This move has been much maligned in financial circles, yet the recent G20 (the 20 largest world economies) conference supported the move, as Japan has been very long suffering in its deflationary (money shortage) economy. This has resulted in what is commonly called the “lost decade” for Japan. The G20 could not do anything but support Japan in the move, as they are in the thick of it themselves.
Many consider the currency war to have been started by President Obama, whose vow to strengthen exports and bring manufacturing jobs back to the US, followed by massive amounts of money creation, is pretty much the definition and desired result of a currency war. The US has a very distinct advantage in a currency war, since being the world’s reserve currency makes US dollars a worldwide commodity, effectively exporting the inflation to keep the domestic impact relatively low.
This crushes economies that cannot print their own money to combat the currency war; economies like Greece, for instance. The end result is that a jar of imported Greek olives on the shelf suddenly jumps 20 percent in price, due to our devalued currency and Greece’s inability to devalue its own at the same time. This causes both American and Greek olive lovers to choose a cheaper California olive to save some money.
That, in a nutshell is what a currency war is all about.
Most developed economies are now actively involved in the currency war, but have been maintaining a relatively modest pace of devaluation.
On February 8, Venezuela lobbed a nuke into a knife fight by devaluing its currency by 46 percent overnight.
While this move could help its economy, if only temporarily, Venezuelans who thought “that will never happen here” and maintained their wealth in something as risky as fiat currency lost 46 percent of their net worth overnight.
The last large scale currency war was in the 1930’s. This era became much better known as the Great Depression. The only effective method to end a currency war so far in our history has been a world war. There must be something about intentionally destroying another country’s economy that makes them belligerent.
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