Currency Wars in Modern Markets: Lose – Lose or Win – Win?

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Currency wars in modern economics are not unusual things. Low value currency is considered beneficial for a number of reasons, at least from the standpoint of big business. Weak currency means cheaper goods, lower production costs and overall economic growth. As a result, many countries deliberately and strategically devalue their currencies. However, is enough countries try to pull that off at the same time, a currency war breaks out.

War of currencies

During currency wars, countries try to gain an advantage over each other thus gaining an upper hand on the international markets. They take turns devaluing their currencies further and further, at no heed to the cost and often causing financial damage to third parties as well. On the bright side, local consumers are “encouraged” to seek domestic alternatives to imported goods. On the other side, productivity is bound to shrink, especially in branches that rely on import, which is being hampered – raw materials, technology, tools etc. are harder to obtain.

For these reasons, it is imperative that currency depreciation be placed in the right hands. Usually, those “hands” belong to the country’s central bank. It makes and enforces this strategy through quantitative easing and changing interest rates.

How could reducing the value of its own money be beneficial for the country’s economy?

Well, the logic is simple: the more value currency loses, the more competitive the country’s products get on the open market. This increases exports while reducing imports; the demand for the country’s products abroad increases, and so does the production – not to mention GDP. In theory, economic boom should offset the negative aspects – ordinary people having less purchasing power, the short-term decrease in living standards, and a whole bunch of other consequences. The worst one is, when one or two countries go down that road, they might start a chain reaction, forcing the hands of other countries just to stay competitive, eventually escalating into a full-scale currency war, which may eventually negate all of the progress they sought to make.

The negative effects of currency wars

Despite artificial incentives, the overall productivity may falter due to several factors, the unmotivated work force being the least among them.  After the initial boost, future trade often gets hampered by new measures and regulations which were not there before the currency war took place. Even the best plan can go awry. No matter the level of control and oversight, currency devaluation sometimes simply gets out of control, causing hyperinflation in percentage measured by thousands and tens of thousands. The effects of hyperinflation are well known and documented. The examples are numerous: North Korea in 2009-2011, Yugoslavia and Zimbabwe during the 1990s, Singapore and Hungary during and immediately after World War II, China in late 1940s etc.

Currency wars
Currency wars

Perhaps the worst consequence in breached trust between nations. Foreign investment is severely impeded – breached trust, hedging costs, unstable currency reputation, you name it. All these factors speak volumes about numerous downsides to currency wars.