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By Elizaveta Belugina, leading analyst at FBS Markets Inc., FXBAZOOKA.com

The current financial system invites so-called ‘currency wars’ between different nations: during the times of economic hardships governments seek to devalue national currencies in order to make their exports more price competitive. Once several players join the game, it provokes a chain reaction: countries which didn’t take part in the battle at first, have to join the fight as their currencies become too expensive compared to those of their neighbors – a very unpleasant thing for export-oriented economies.

As all parties are contending with the same ammunition but for contradictory goals – namely their own well-being at the expense of others – it raises an important question: who will win in this currency confrontation? Can it be that everyone wins? And are there winners at all?

The sheer fact that regulators all over the world keep easing monetary policy means that the existing measures are not enough: the economies suffer, so there’s a need for additional stimulus. Some economists even don’t rule out the possibility of QE4 in the United States.

Monetary easing – both conventional and unconventional – is a real mayhem these days. Here’s the list of the central banks which lowered the benchmark interest rates since the beginning of 2015: Romania (4), India (3), Switzerland, Egypt, Peru, Denmark, Turkey (2), Canada, Pakistan (3), Albania, Russia (4), Australia (2), Sweden (2), Indonesia, Israel, China (4), Poland, Thailand (2), South Korea (2), Serbia (4), Hungary (4), Sri Lanka, New Zealand, and Norway – the list is quite impressive. All in all, since Lehman Brothers collapse central banks have lowered interest rates more than 570 times. The European Central Bank has resisted monetary stimulus for a long time, but eventually even Mario Draghi had to give green light to the quantitative easing (QE).

Let’s have a look at some countries’ Real Effective Exchange Rates (REER), which provide a measure of their export competitiveness: a rise in the index implies a fall in competitiveness, and vice versa.

real effective exchange rate

Source: BIS

As you may see from the chart above, quantitative easing helped to increase the US competitiveness in 2009-2011. However, as the Federal Reserve ended the third round of asset purchase program in 2014, US dollar’s REER went up. This represents a negative factor for American economy showing the most dangerous thing about the loose monetary policy: once you start it, it’s very difficult to turn it off, because the economy, the stock market and practically everyone become too used to the cheap money. This addition not only creates an ever-present risk of uncoiling inflation, but also raises a vicious circle of constant easing and currency wars.

If there are winners, there should be losers. As one currency weakens, other currencies inevitably rise. It’s evident that hot money poured out of the US to emerging market economies like Brazil making its national currency appreciate. That’s why the country had a huge loss of competitiveness during the same period. Big monetary inflow made asset and food prices in Brazil rise magnifying inflation. Even now high inflation prevents Brazil from joining other central banks in cutting interest rates with full force. And when the US finally raises interest rates, it will cause more of the violent capital flows, but in other direction, and it won’t be pretty.

It’s clear that the world’s financial system requires more and more monetary stimulus. Central banks cut interest rates and buy their own governments’ bonds in order to print extra money and hold interest rates at the record lows thus stimulating demand and investment. Moreover, weaker national currencies help to devalue huge public debts. All in all, the aim itself is good, but the road to hell is paved with good intentions. The problem is that QE increases exchange rate volatility. As a result, international companies have to hedge more, and the cost of cross border transactions rises. Foreign direct investment also suffers, and financing becomes more expensive for countries with current account deficits. Excessive expenses are a burden for economic growth. All in all, the state of currency wars complicates co-operation of economic and trade partners creating barriers in their way.

Elizaveta Belugina
Elizaveta Belugina

Aren’t there other ways to encourage economic growth other than the loose monetary policy? Of course, there are. But quantitative easing offers quicker results. As most advanced economies suffer from low inflation and subdued economic growth, it’s natural for their central banks to conduct loose monetary policy which is debasing the currencies. What the nations don’t realize is that they are singing a deal with the Devil and that it will be very difficult to get off the hook.

To sum up, in the short-term there are some winners and losers of currency wars: countries which manage to achieve acceleration in growth, and countries which are hurt because their competitors have made their own exports cheaper. In the long term quantitative easing causes plenty of problems for everyone. So far what we have seen is that one round of currency war provokes the next one.

According to Josef Stiglitz, currency wars have no winners. The gains of a county which is devaluing its currency look smaller than the losses of the other countries which are hit by the consequences of such policy. As all nations are tied up together in the globalized word, these small gains tend to evaporate with time as countries suffer from the troubles of their partners. This wise economist warns that in 1930s policies aimed to hurt the neighboring countries made the Great Depression last longer. Stiglitz offers an alternative way –global co-operation based on structural reforms, economic stimulus and long-term institutional changes in the global monetary system. The US as the owner of the world’s main reserve currency and the originator of currency wars in the first place should play the leading role in making the various nations cease monetary fire. To establish the currency peace America has to demonstrate a positive example by pioneering high productivity investments and wage increases. This is not the easiest way, and it will take time before the policymakers finally realize that this is the best solution. Until then currency wars will keep rocking the world economy preventing it from sustainable growth.