Can the World Avoid Currency Wars?

  • 11 October 2010

After exhausting their options to bring about economic recovery it now appears that the major world powers have resorted to devaluing their currencies as an instrument to prop up their economies. In recent months China has made currency interventions despite its Central Bank playing down the importance of such measures. Yet its admittance of even a small difference between market price and actual value of the Yuan is seen as indicative of the level of intervention. In recent weeks, Japan has also heavily intervened in the currency market to devalue the Yen by buying foreign currencies in its bid to stop its continuous rise against other currencies. The recent decline in the value of the dollar also demonstrates the US attempts to intervene in the currency market in order to increase spending to boost the country’s economic recovery. This can be explained by the fact that a weak currency is an effective tool to support exports as it reduces the cost of exports and improves its competitiveness in the global market.

Rising number of countries resorting to this tool is considered an indication of its effectiveness as more and more countries find weak currency as a means to support exports at a time when the global financial crisis continues to burden the global economy. As this becomes the order of the day and expands to other countries prospects of a conflict between major economic powers over currency value looms large. This is likely to take the form of a currency war which can create volatility at major international exchanges. This could even lead to the entire international financial system entering into a period of uncertainty.

Such a war has the potential to damage the global economy which can impact investment decisions in commodities market, especially oil, and in other sources of energy. This will make gold a strategic option for saving and investment at the same time and will weaken the importance of other alternative savings and investments due to the instability of their values and returns leading to weaknesses in the global economic growth engines. The war of currencies can also provide a fertile ground for manipulation of currency exchange markets and may force countries to interfere even more to eliminate volatility owing to speculation. Volatility in currency markets can weaken the intervention mechanism in these values as a tool to support exports and this volatility can negatively reflect on exports.

Under these circumstances it is necessary for the International Monetary Fund and other such organizations to uphold international monetary and financial stability and maintain the fundamentals by balancing the entire financial system. This will protect the interests of the countries affected by it, especially those in the emerging world. While the major responsibility rests on such organizations, this does not exempt developed countries from exercising influence and taking measures to prevent such practices from going out of hand.