Is a Global Currency War Still Possible? - Flossbach von Storch
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A SYMPOSIUM OF VIEWS
Is a Global Currency War
Still Possible?
I
n 1985, with the U.S. dollar soaring in close-to-negative real interest rates, what
strength particularly against the yen, are the chances that currency devaluation
industrialized world policymakers saw (disguised or otherwise) becomes the
the elements forming for a dangerous all- preferred policy instrument for growth?
out trade war. They agreed on what became And how will U.S. policymakers respond
known as the Plaza and Louvre Accords, if the dollar strengthens significantly as
efforts at international cooperation to other nations engage in aggressive global
contain currency pressures. Global financial monetary stimulus led by the European
markets responded positively to this Central Bank? Will the end result be a
emerging international financial statecraft. twenty-first century currency war?
With the Trump Administration’s And will lowering a currency’s value
imposition of tariffs, that statecraft has even guarantee greater prosperity? What
all but collapsed. To complicate matters, would be the effect of a currency war on
tariffs, trade, and the financial policing of global financial markets? On emerging
international capital flows (backed by the markets? To what extent has the world’s
dollar’s role as the reserve currency) have prosperity of the last forty years depended
all become major weapons in America’s on a successful international economic and
foreign policy arsenal. financial statecraft, the foundation of which
In this new go-it-alone era, the question now appears to be at risk?
is whether the world’s major non-U.S.
central banks, under pressure from their
governments, respond with aggressive
monetary policies designed precisely for
the purpose of weakening their currencies
with the hope of making their exports
more competitive. After all, the Bank
for International Settlements has just
proclaimed that monetary stimulus
in and of itself can no longer be the
“main engine of economic growth.”
In a world already experiencing tepid
economic growth despite negative or
More than two dozen noted experts
offer their analyses.
16 THE INTERNATIONAL ECONOMY SUMMER 2019as an effort to procure much-needed global public goods,
not only to address old challenges such as an evenhanded
Globalization and and balanced approach to trade, flexible exchange rates,
foreign direct investment, and the international financial
multilateralism architecture, but also new ones, such as climate change
and more inclusive growth and development.
are in crisis. An issue that has gained increased attention is the
role of monetary policy and its implications, spillovers,
and tradeoffs for foreign exchange dynamics, trade perfor-
mance, and growth. An extreme and narrow view considers
competitive devaluations, race-to-the-bottom policies, and
even so-called currency wars. These arguments misunder-
ALEJANDRO DÍAZ DE LEÓN stand currency markets and the role of the exchange rate,
Governor, Bank of Mexico and may lead to the confusion that monetary policy should
set real exchange rate objectives for competitive purposes.
T
rade tensions have become a major obstacle to global In this regard, history and theory provide ample
economic growth, with significant effects on manu- evidence that monetary policy should focus on attain-
facturing production, investment, and business con- ing low and stable inflation, hence contributing to output
fidence. Current purchasing manager surveys show that a smoothing and financial stability, and not on targeting the
contraction in manufacturing may already be underway. exchange rate. To this end, central bank independence
Disruptions in global value chains have affected the most is of paramount importance in attaining a well-focused,
globally integrated processes and dampened business in- medium-term–oriented monetary policy, with ample and
vestment. These adverse impacts have been more severe much-needed distance from political cycles.
in economies more open to trade and with large export We must not forget that on the road to development,
volumes to the United States. at both the national and global levels, we need to rec-
Markedly weak investment stands out as one conse- oncile individual (national) interests with the common
quence of a highly uncertain environment due to trade and (global) good. History has taught us that short-sighted
geopolitical tensions. In the last few years, particularly in approaches lead to mirages at best, or extremely painful
Mexico, these factors have triggered a strong pushback on lessons at worst.
investment, directly in manufacturing, but also, indirectly,
in services.
The baseline scenarios for global growth have already
been affected and large downside risks prevail, as a more
hostile environment to trade and investment seems to be Exchange rates
more permanent. This is especially so since recent trade
tensions are related not only to bilateral trade deficits, but matter far less
also to technology supremacy and immigration issues, as
is the case with Mexico regarding the latter factor. than they used
The multilateral institutions, strategies, and ap-
proaches put in place since Bretton Woods seventy-five to, especially in
years ago face deep structural challenges. Arguably, glo-
balization and multilateralism are in crisis, both from the developed countries.
heightened pressure from protectionists and nationalist
agendas and from the accumulated costs and tensions de-
rived from global imbalances, associated in part with some TADASHI NAKAMAE
countries’ use of managed exchange rates and export-led President, Nakamae International Economic Research
growth strategies.
C
To attain growth and development, market economies urrency strength, or weakness, is no longer a bell-
need to engage with each other in a mutually constructive, wether of economic performance for developed
predictable, and evenhanded way. History and theory show economies. The global economy is less dependent on
that national interests are best served by international co- trade than it was forty years ago. Exchange rates matter far
operation. Multilateralism seeks to find solutions to global less than they used to, especially in developed countries.
externalities through cooperative approaches that improve Take Japan’s automobile industry, its top export
both national and global outcomes. This can be considered industry. In 1985, overseas production by Japanese
SUMMER 2019 THE INTERNATIONAL ECONOMY 17automakers was almost non-existent. In 1990, they pro- one side are the interests of local communities, businesses,
duced 3.3 million units overseas, less than a quarter of the and consumers, who, at best, derive little benefit from a
13.5 million units they produced domestically (16.8 mil- weaker currency, or worse, are hurt by currency or trade
lion units in all), while selling around 7.5 million cars at wars. On the other side are the executives of multinational
home and exporting 4 million. companies, whose wealth is tied to higher corporate prof-
By 2018, Japan’s automakers were producing 20 mil- its and share prices, and thus a weaker currency. The way
lion units overseas and only 9.7 million units at home (of in which “currency wars” is framed is flawed and distracts
which only half, 4.8 million units, were exported). from the real and immediate problems of economic polar-
This means currency matters in different ways now. ization, inefficiencies, and inequity within countries today.
Today a weaker yen bolsters Japanese automakers’ yen-
based profits from overseas production. But it does not
stimulate an industry’s (or country’s) exports, raise produc-
tion, or create lots of new jobs at home as it did in the 1980s.
A weaker yen did lead to higher stock prices and as- The vehicle for
set inflation, although this did not stimulate consumption
or investment the way Shinzo Abe, the prime minister and a crisis, perhaps
the leader of the Liberal Democratic Party, had hoped.
Consider the three years between 2009 to 2011 (in- deeper than 2008,
clusive), when the Democratic Party of Japan was at
the helm, and the Bank of Japan was run by Masaaki may be an exchange
Shirakawa. During this time, the yen strengthened (at an
annual rate of -5.2 percent) and prices dropped (the GDP rate war.
deflator was -1.5 percent). Nominal GDP growth was 0.4
percent, but real GDP growth was much higher at 1.9 per-
cent. Dollar-based GDP grew 5.8 percent (from $5.2 tril- DAVID C. MULFORD
lion to $6.2 trillion). Former U.S. Ambassador to India, and former Under
By contrast, between 2012 and 2018, after the LDP Secretary for International Affairs, U.S. Treasury
was back in power, the Bank of Japan, led by Governor
T
Haruhiko Kuroda, loosened monetary policy aggres- he Plaza Accord of September 1985 marked a high
sively as part of “Abenomics.” During this period, the point in cooperation and policy coordination be-
yen weakened 5.6 percent. As a result, prices rose 0.6 tween the G5 countries in the evolution of global
percent. Nominal GDP grew 1.7 percent but real GDP financial markets. At that time, a consensus was achieved
growth was only 1.1 percent, lower than the preceding between both surplus and deficit countries in the G5 to
years. Dollar-based GDP shrank to $5 trillion from $6.2 cooperate in depreciating the dollar by 40 percent over a
trillion in 2012. Meanwhile, per-capita wages and labor period of eighteen months. The G5 decision to cooperate
productivity stalled. was motivated by fear of a trade war involving the pros-
A weaker currency only works to stimulate or revital- pect of tariffs and possibly beggar-thy-neighbor exchange
ize an economy (at least in any significant way) in emerg- rate actions.
ing countries undergoing rapid industrialization. Even Today we face a new situation that could lead to a
China’s dependence on trade has fallen to 18 percent in major international financial crisis. First, unlike in 1985,
2018 from 33 percent in 2007, now that it is near the end we already have a trade war which appears to be spreading
of its era of industrialization. These days, China, saddled and deepening tensions.
as it is with cross-border debt, is unlikely to welcome a Second, the G5 has atrophied significantly since the
weaker yuan as it once did. late 1990s, while the G20 group has increased in size and
The real conflict over currency is no longer between media prominence, while declining in effectiveness.
countries. In developed countries, a weaker currency no Third, there are now three separate players in the world
longer helps the economy in the meaningful ways it once who seek to strengthen their respective power in global
did. But the (outdated and inaccurate) perceptions of its monetary, financial, and political affairs: the United States,
benefits still help politically, through promises of raising China, and the European Union. There is no small nucleus
exports, production, and new jobs. It also helps distract of leading world powers that is working together effectively
from real, thorny economic issues that are troubling local outside the spotlight of the global media to resolve issues
communities. related to large imbalances in the global economy.
There is a growing conflict over weaker currencies, but Fourth, no progress is being made, or even attempt-
it is an internal (domestic), and largely invisible one. On ed, to reform the world’s post-Bretton Woods monetary
18 THE INTERNATIONAL ECONOMY SUMMER 2019system, or to re-establish a consultative G5 or G7 group of business spending, the textbook response is a rapid easing
major nations to rebuild the confidence needed to restore of monetary and fiscal policies. But actual and perceived
constructive economic dialogue. limits on monetary and fiscal policies in major economies
Taken together, prospects for an “exchange rate imply that these policies may not be used sufficiently to
war” have strengthened. If trade tensions continue to foster a strong recovery. Policymakers will be tempted to
build, and we experience a recurrence or worse of the use foreign exchange intervention and capital controls to
2008 crisis, it would seem that without some improve- weaken their currencies and gain export-led growth at the
ment in global economic governance and monetary co- expense of others. Strong collective leadership is needed
operation, an eventual exchange rate war appears to be to avoid currency conflict. The G20 pledge to avoid tar-
inevitable. geting exchange rates for competitive purposes is a good
China is faced with declining growth, severe demo- place to start, but we need to extend this understanding
graphic constraints, structural reform issues, and the dis- beyond the G20 and agree on sanctions to be used to deter
advantages of authoritarian rule. Slower economic growth, currency transgressors.
rising indebtedness, and a weakening of its currency will Fiscal expansion, which puts upward pressure on a
ultimately produce destructive capital flight. country’s currency, has positive spillovers in the context
Europe is facing the economic and political fallout of of a global recession. Monetary expansion, which puts
Brexit, the prospect of declining cohesion among its re- downward pressure on the currency, is sometimes viewed
maining states, and the widening recognition that the euro as having negative spillovers. But this view ignores the
has been chiefly to the advantage of Germany versus the boost to domestic spending, which bolsters imports and
European Union’s other member states. roughly offsets the negative spillover from a weaker cur-
The United States is not able to re-establish its for- rency. The true weapons of currency conflict are sterilized
mer position as the world’s preeminent leader in trade intervention in foreign exchange markets and one-sided
and monetary affairs. This weakness implies an inability capital controls, which redirect aggregate demand from
to manage and hopefully control economic and financial trading partners to the intervening country without any
conflicts that can lead to destructive results. offsetting positive effects.
Meanwhile, the world’s major central banks continue The policy conundrum in the next recession is most
to believe that cutting interest rates—even to negative lev- apparent in the euro area and Japan. Policy interest rates
els—will enhance world growth, when the evidence of the (and even long-term government bond yields!) in these
last decade tells a different story of slowing growth, weak- economies are already negative and lowering them more
ening currencies, and bloated central bank balance sheets. than another half of a percentage point is not likely to be
The vehicle for a crisis, perhaps for a deeper crisis useful. There is only modest scope for further stimulus
than 2008, may well turn out to be an international ex- through purchases of peripheral and private bonds. Equity
change rate war. purchases could be effective, and Japan is doing a small
amount of them, but it is not clear whether large-scale equi-
ty purchases by central banks would be politically feasible.
Meanwhile, historically high levels of government debt in
Japan and several euro-area countries raise political barriers
The euro area to using fiscal policy forcefully to restore growth.
Policymakers in the euro area and Japan may be
and Japan may be tempted to intervene to weaken their currencies in the
event of a new recession. However, the world should not
tempted to intervene condone aggressive currency policies in these or other
economies with significant trade surpluses. Rather, the
to weaken their correct policy mix in the euro area and Japan is to use
whatever monetary room is left and to use fiscal policy
currencies. aggressively. In today’s world of ultra-low interest rates,
which are expected to persist for many years or even de-
cades, governments can manage much higher debt levels
JOSEPH E. GAGNON than the old rules of thumb envisioned.
Senior Fellow, Peterson Institute for International Economics China and the United States have considerably more
room to ease monetary policy, and they should do so
E
conomic expansions do not die of old age, but they rapidly in the event of a new recession. They also have
do die from other causes. Should a trade war or other substantial fiscal space that might be used. If there is any
shock cause a widespread collapse in consumer or major economy that might be justified in using currency
SUMMER 2019 THE INTERNATIONAL ECONOMY 19policy in the next recession, it is the United States, which the comparative advantages that matter in international
has an unsustainable trajectory of net international debt trade, has dominated the discussion. But the idea is un-
owing to chronic trade deficits. Correcting the U.S. trade realistic. Ricardo assumes that everybody and all econo-
deficit may require a different monetary-fiscal policy mix mies are full employed in a stationary economy. In the real
along with some intervention in foreign exchange mar- world, however, no economy is ever working at full capac-
kets. But in the event of a global recession, the United ity and without a possibility to increase its capacity. Every
States should refrain from direct currency action pro- producer or national economy, given absolute advantages
vided that its trading partners also refrain. Dealing with and free capacities, will use all available absolute advan-
the U.S. trade deficit should wait until global recovery is tages, and will not abstain from producing the products
firmly established. where they have an absolute and a comparative advantage.
In addition, Ricardo assumes that—at full employ-
ment—the remuneration of the workforce precisely re-
flects the respective scarcity of labor and capital in all
participating countries. In reality, however, nominal val-
ues are decisive for international trade because, together
Yes, the western with currencies (exchange rates), they determine prices.
With inflation rates and unit labor costs varying widely
world is flirting with between countries, there has to be a functioning mecha-
nism to ensure that widely divergent price and wage dy-
a currency war. namics remain closely tied when calculated in an interna-
tional currency.
However, this is not the case. Currency markets have
become the playground of speculators. The relative values
of currencies are often driven in the completely wrong di-
rection for years, as speculators “carry currencies” to take
HEINER FLASSBECK advantage of inflation and nominal interest rate differ-
Director, Flassbeck-Economics, and Former Director, ences. In this way, currencies of countries with high infla-
Division on Globalization and Development Strategies, tion appreciate, and those of countries with low inflation
United Nations Conference on Trade and Development depreciate, which is exactly the opposite of what would
be necessary to rebalance trade. Brazil is the classical ex-
Y
es, the western world is flirting with a currency war. ample and it was a Brazilian finance minister who spoke
The reason is simple: Most countries have run out of years ago about a currency war.
traditional instruments of monetary policy and they Trump is also right in insisting that “global imbal-
are facing a cyclical slowdown at the same time. More ances” stand in stark contrast to the free trade doctrine.
and more countries have to rely on unorthodox measures. Surpluses or deficits in trade reflect absolute advantages
Devaluation of the currency seems to be an easy way to and should be prohibited. But huge imbalances and huge
stimulate a major macroeconomic price when the interest swings in exchange rates are ignored by many “free
rate is no longer available and expansionary fiscal policy traders.”
is taboo. A new world monetary order must regulate monetary
The dangers inherent to this approach are obvious: relations between the major blocs, and at the same time
competitive devaluations will destabilize the system and give smaller countries the opportunity to tie their curren-
no one can benefit. President Trump insists on fair trade— cy to one of the those blocs. If goods and capital are to
whatever he may mean by that—but the Europeans, led move rather freely worldwide, sustainable solutions must
by neo-mercantilist Germany, insist that trade has to be be found for rational currency relations between regions,
“free.” The problem is that “freedom” cannot mean free- which, for whatever reasons, are not able to achieve rapid
dom (or absence) of any rules and regulations and defini- convergence in cost and inflation trends.
tively not absence of any rules concerning currencies. Without a rational international monetary system,
The problem is a more general one. A large majority currency wars cannot be avoided. Exchange rate adjust-
of economists defends “free trade” with tooth and claw. ments have to be closely tied to the differences in infla-
Nothing is as sacred to liberal economists as free trade. tion rates and must not be left to the market. In a reason-
But the “theory” is based on a questionable doctrine the able world monetary order, exchange rates must be stable
English economist David Ricardo postulated two hundred enough to allow rational investment decisions, yet also
years ago. His famous “principle of comparative advan- flexible enough to maintain the international competitive-
tage,” according to which it is not the absolute but rather ness of all participating states.
20 THE INTERNATIONAL ECONOMY SUMMER 2019simply in an effort to get fiscal policymakers to act. We
have a technical economic term for such monetary inac-
The world’s central tion: it’s called “cutting off your nose to spite your face.”
banks are not
gearing up for
a currency war. There are some
worrisome parallels
BARRY EICHENGREEN between the 1930s
George C. Pardee and Helen N. Pardee Professor
of Economics and Political Science, University of and today.
California, Berkeley
I
don’t see the “major non-U.S. central banks, under
pressure from their governments, respond[ing] with THOMAS MAYER
aggressive monetary policies designed precisely for Founding Director, Flossbach von Storch Research Institute,
the purpose of weakening their currencies.” I see them and former Chief Economist, Deutsche Bank
as loosening conventional and unconventional monetary
T
policies with the goal of bringing inflation up to target, here are some worrisome parallels between the
and doing so more aggressively as the economy and in- 1930s and today. In June 1930, less than a year af-
flation rate weaken. The central banks that move fastest ter the stock market crash of October 1929, the U.S.
and furthest in the direction of loosening will also, more Congress passed the Smoot-Hawley Tariff Act. U.S. tar-
likely than not, see their currencies weaken as a result. iffs went up significantly and numerous countries retali-
But weakening the exchange rate is not their express pur- ated with tariff increases of their own. In September 1931,
pose. It is not their primary objective. Certainly this is not the United Kingdom went off the gold standard. Sterling
the express purpose or primary objective of the European was devalued against gold and the currencies of countries
Central Bank, the central bank at which this criticism has remaining in the gold bloc. Several other European coun-
recently been trained. tries followed the United Kingdom only a little later. The
To the contrary, the danger comes not from non-U.S. gold bloc countries lost competitiveness and their exports
central banks but from the United States, and not from the weakened, which exacerbated their economic downturn.
central bank but the Treasury. It is that the U.S. Treasury In Germany, the depreciation of other European cur-
will use the Exchange Stabilization Fund to push down the rencies stifled the policy of internal depreciation followed
dollar, President Trump seeing a strong dollar as frustrating by Chancellor Heinrich Brüning. In 1934, the Roosevelt
his efforts to enhance the competitiveness of U.S. manu- administration devalued the U.S. dollar against gold, and
factures and agricultural products on international markets. in 1936 the countries remaining in the gold bloc followed.
Trump sees foreign trade in terms of mercantilism. And this The 1930s have gone down in history as a period of weak
use of the Exchange Stabilization Fund would be monetary and volatile economic performance with an eventually ter-
mercantilism at its worst. Foreign central banks and gov- rible political fall-out.
ernments would not regard this favorably; they would see Today, we have seen several rounds of tariff increases
it as an explicit beggar-thy-neighbor policy. Successful in- between the United States and China, and another round
ternational economic and financial statecraft would then be between the United States and the European Union could
directly at risk—if it isn’t at risk already. soon follow. President Trump is accusing other countries
I also don’t see the warnings of the Bank for of trying to weaken their currencies by contemplating an
International Settlements, mentioned in the editor’s query, easier monetary policy, and he is putting pressure on the
as particularly pertinent here. Certainly it would be desir- Federal Reserve to counter presumed currency manipula-
able if fiscal policymakers did more of the hard macro- tions. If we continue on this path, we may well end up in
economic lifting, adjusting fiscal policy in sensible ways an environment similar to that of the 1930s, characterized
to support economic growth and stability. But it makes no by economic instability, financial fragility, and declining
sense for central banks to call a sit-down strike, and to welfare. We can only hope that the political consequences
refuse to take action to push inflation up toward 2 percent, will not be as bad as then.
SUMMER 2019 THE INTERNATIONAL ECONOMY 21Consequently, efforts are needed to avoid a repeat of offset fragile domestic growth dynamics being aggravated
history. If the U.S. administration cannot be persuaded to by contractionary trade winds, the tools would involve a mix
abandon its 1930s-style trade and currency policies, other of unusual monetary policy loosening, competitive devalu-
countries must create free-trade zones and intensify curren- ations, and perhaps even some explicit market intervention.
cy cooperation among them. With the EU countries being As worrisome as all this would be in deepening global
the biggest player on the global trading scene, the European economic fragmentation, there’s a silver lining associated
Union needs to take the lead. Earlier this year, the EU-Japan with this additional cloud hanging over a global economy
Economic Partnership Agreement entered into force and in that already struggles to deliver high and inclusive growth.
July the European Union concluded a trade agreement with It’s about policy choices.
the Mercosur countries of South America. The big hope is that concern about the spread of
With the European Union having been a long- beggar-thy-neighbor foreign exchange moves would
standing ally and friend of the United States, similar ar- serve as a catalyst for long-overdue adjustments in do-
rangements with China could be seen as taking sides in mestic policies, as well as for better global policy interac-
the U.S.-China battle for global leadership. However, tions—both of which would help contain other risks fac-
the fact that President Trump regards China—along with ing the global economy.
Russia and the European Union—as a foe of the United The risk is that policies will continue to lag, increasing
States does not imply that the European Union should that dreadful probability of global recession, financial insta-
also regard China as its foe. Hence, if the U.S. administra- bility, and an erosion in policy flexibility and effectiveness.
tion intensifies its hostility against the European Union,
the European Union may have no other choice than to ex-
tend its cooperation pacts also to China. A few southern
European countries have already opened the door by em-
bracing China’s One Belt, One Road initiative. What should really
concern us is not
A “currency war” currency wars but
could be the next the over-reliance on
stage for a world monetary policy.
heading towards
JASON FURMAN
greater economic Professor of the Practice of Economic Policy, Harvard
University’s Kennedy School, and Nonresident Senior Fellow,
fragmentation. Peterson Institute for International Economics
N
MOHAMED A. EL-ERIAN othing excites the imagination as much as a war.
Chief Economic Advisor, Allianz; Chair, President Obama’s And for those of us who work in economics where
Global Development Council; and author, The Only Game we do not have shooting wars, we have to settle for
in Town: Central Banks, Instability, and Avoiding the Next getting excited about “currency wars.” Unfortunately, the
Collapse (Random House, 2016) term has been stretched so far that it long ago lost any
coherent meaning and more often serves to confuse our
A
bsent a change in policy approach by the systemical- understanding of macroeconomic policies. More impor-
ly most important countries, a “currency war” could tantly, it distracts us from putting more emphasis on a
well be the next stage for a world heading towards potentially more fruitful global macroeconomic dialogue
greater economic fragmentation, losing economic mo- around expansionary fiscal policy.
mentum, and lacking adequate global policy coordination. Let’s start with the economics. All monetary policy
The catalyst would be the further depreciation of the operates through a domestic channel (via wealth effects
floating currencies of open economies, particularly those and the cost of capital) and through an international
being negatively impacted by global trade uncertainty. The channel (via exchange rates). Absent capital controls, it
amplifier—and driver of contagion among countries— is effectively impossible to conduct domestic monetary
would be slowing global growth. And as countries try to policy on a sustained basis without affecting exchange
22 THE INTERNATIONAL ECONOMY SUMMER 2019rates. Conversely, it is also effectively impossible to af-
fect exchange rates on a sustained basis without chang- I am not convinced
ing domestic monetary policy—with the limited and often
ephemeral effects of sterilized interventions and cheap that advanced
talk corroborating this point.
When Brazil in 2010 or the United States today ac- economies are
cuses other countries of engaging in a “currency war,”
they are right in a narrow sense. U.S. policy was weaken- about to enter a
ing the dollar in 2010 and eurozone policy is weakening
the euro today. The policies, however, were fully expli- currency war.
cable by domestic conditions. In 2010, the United States
was in a deep economic hole and inflation was low, and
today the eurozone remains below potential with inflation LORENZO BINI SMAGHI
well below its policy ceiling. As a general matter, it would Former Member of the Executive Board, European
be odd to expect many countries at any time to engage Central Bank
in monetary policies that deviated substantially from their
I
objectives for internal balance. am not convinced that advanced economies are about to
Moreover, expansionary monetary policy in a home enter a currency war for several reasons.
country has countervailing effects on the foreign econo- First, experience has shown that it is not that easy for
my. Specifically a monetary expansion increases foreign policy authorities to influence exchange rates. Unilateral
exports through the income effect of stronger demand but interventions in the foreign exchange market have very
reduces them through the substitution effect of a stronger little impact on the relative price of monies. Even when
currency. Economists are much less sure of the net sign interventions are not sterilized, they hardly succeed in
than are policymakers and politicians levelling charges of moving markets. The rare episodes of exchange interven-
“currency wars.” tions that have had some effect in the past were generally
There are a limited and very important exceptions to agreed and coordinated between the monetary authorities
this general logic. Capital controls or reserve accumulation of the major economies, in particular in the context of the
can be used to persistently weaken a currency, driving a G7, and aimed at correcting some evident mispricing in
wedge between exchange rate policy and monetary policy, financial markets. The last time major economies inter-
as China did for more than a decade after its entry into the vened in a coordinated way was in the summer of 2000, to
World Trade Organization. In this case, international pres- counter a quick and sharp depreciation of the euro against
sure was warranted, possibly even greater than was brought the dollar. The impact was limited and short-lived.
to bear, but ultimately the misalignment of Chinese macro- Second, there is currently no evidence of a major ex-
economic policy with its domestic considerations, includ- change rate misalignment with respect to the underlying
ing its desire for stronger domestic demand, was the most economic fundamentals of the major economies. Over
important factor bringing about change. the last few years, exchange rates have fluctuated within a
Most of the time, however, the term “currency war” relatively narrow band, reflecting the different underlying
is confused both about the motives of the country that conditions in the major areas. The relative strength of the
declared war as well as the impact of its actions. This dollar has been in line with the more robust U.S. recovery
confusion comes at a cost—responding in kind could be and the consequent tighter monetary conditions.
feckless (like if the United States had decided to engage Third, it is not in the interest of the major countries
in exchange rate intervention) or even counterproductive to give the exchange rate a more prominent role within
(like if a country reorients its monetary policy away from their respective monetary policy framework. This would
domestic goals and toward an exchange rate goal). reduce the degrees of freedom of the central bank and
Being distracted by imaginary currency wars dis- subordinate monetary policy to external conditions. It
tracts countries from pushing each other on the more would dis-anchor market expectations from the national
positive-sum macroeconomic policy to combat common economy and ultimately lead to a higher risk premium on
shocks: fiscal policy. A fiscal expansion in China in 2005, domestic assets.
the United States in 2010, or the eurozone today would Fourth, in the current environment, interventions
strengthen domestic demand in a manner that has unam- would be interpreted as an attempt to manipulate the exter-
biguously positive global spillovers. What should really nal value of the currency. If the U.S. authorities took such
concern us is not currency wars but the over-reliance on an initiative, they would no longer be able to accuse other
monetary policy that has come about, in part, because of countries of doing the same, which would undermine the
exaggerated fears of fiscal expansion. main reason for retaliating through trade measures.
SUMMER 2019 THE INTERNATIONAL ECONOMY 23Fifth, intervening in the foreign exchange markets followed by “competitive devaluation” of currencies, start-
to depreciate the value of the currency would imply ac- ing with Britain, followed by the United States and others
cumulating large amounts of foreign exchange reserves, as they left the gold standard and allowed their currencies to
whose value would vary depending on market valuations. depreciate against those still on the gold standard. Germany
This would expose the balance sheet of the central bank to was an exception: it deployed currency controls to restrict
large potential losses, which would lead to a reduction of imports, fearful of the impact of currency depreciation on
seignorage, and thus lower fiscal receipts. inflation, still a fresh memory from 1923.
Policy authorities do not always act on the basis of a There are of course inhibitions to currency deprecia-
rational analysis of the pros and cons of various measures. tion. One, as in Germany of the 1930s, is fear of stimulating
It can thus not be excluded that they may at some point be inflation and inflationary expectations, particularly in those
tempted to interfere with market mechanisms and try in- countries that have finally succeeded in reducing histori-
fluencing the external value of their currency. If this were cally high inflation rates during the past decade. A second is
to happen, the sooner they will realize that such an attempt fear of bankruptcy of domestic firms with foreign-currency
is futile—and possibly even counterproductive—the least denominated debt, which includes many emerging markets,
damage they will ultimately do. including China; currency depreciation raises the local cur-
rency burden of this debt, without (except for exporting
firms) increasing their revenues. Far from increasing growth
and employment, such a resulting burden might generate a
local recession and unemployment. A third is concern about
raising government deficits through the need to service pub-
In a sense, lic foreign-currency–denominated debt, possibly creating a
balance-of-payments crisis and leading to a need to cut gov-
a currency war has ernment expenditures and/or raise local taxes, again putting
downward pressure on growth and employment rather than
already taken place. stimulating them.
Again, the real concern today should not be over
“currency wars” but over an unraveling of the world trad-
ing system through tit-for-tat increases in tariffs along
with emulation by other countries less fortunate than the
United States in enjoying a robust economy.
RICHARD N. COOPER
Maurits C. Boas Professor of International Economics,
Harvard University
I
n a sense, a currency war has already taken place, al-
though I would not call it a “war.” As a result of the The world has been
financial crisis and subsequent recession, the U.S.
Federal Reserve lowered the federal funds rate to near in a currency war
zero and pursued three episodes of “quantitative easing,”
with the aim of lowering long-term interest rates as well. for about a decade.
Other central banks emulated the Federal Reserve, which
in contrast started raising the federal funds rate by small
increments in December 2015. The result has been an ap-
preciation of the U.S. dollar against virtually all curren-
cies during the past five years—influenced also of course
by non-monetary developments such as the stronger U.S. WILLIAM R. WHITE
economic recovery, the emergence of U.S. production of Former Economic Adviser, Bank for International Settlements
shale gas and oil, and the desire of investors around the
F
world to put some of their assets into the United States. ar from “flirting soon” with a currency war, we have
The real risk today is not currency war but a tariff been actively involved in such a war for almost a de-
war, initiated by Donald Trump, followed by retaliation by cade. When the U.S. Federal Reserve supplemented
U.S. trading partners. lower policy rates with unconventional policy measures in
This is the reverse pattern of the disastrous 1930s, where 2010, it led to a reversal of the dollar strength generated by
countries first deployed tariffs to generate employment, its safe haven status during the crisis. While subsequently
24 THE INTERNATIONAL ECONOMY SUMMER 2019continuing in public to advocate a “strong dollar policy,”
U.S. policymakers actually welcomed this weakness. A
lower dollar increases demand for U.S. products and em- Rumors of war? Yes.
ployment and helps raise inflation towards target levels. It
also contributes to a lower current account deficit and the Actual war? No.
associated buildup of external debt. Finally, a lower dollar
directly reduces the net value of external debt, since the
dollar value of external assets rises as the dollar falls. For
the same reasons, the strength of the dollar since 2015 has
been found discomforting in Washington.
However, other countries did not welcome the in-
crease in the value of their currencies implied by dollar
weakness. Similar to the United States, most also faced WILLIAM R. CLINE
problems of inadequate demand, rising unemployment, President, Economics International Inc., and
and below-target inflation. Moreover, increased current Senior Fellow Emeritus, Peterson Institute for
account deficits or reduced surpluses constrained export- International Economics
led growth strategies, pioneered by post-war Germany
T
and Japan and later followed by many others. Finally, the he most explicit form of currency warfare is aggres-
wealth gains generated for the United States by the lower sive intervention to prevent appreciation despite a
dollar were recorded as losses elsewhere. large external surplus. In 2006–2007, the U.S. cur-
Given these concerns, many countries indulged their rent account deficit reached 6 percent of GDP, China’s
“fear of floating” by explicit foreign exchange interven- surplus reached 10 percent of GDP, and China intervened
tion (mainly emerging economies) and/or by mimicking massively to prevent appreciation of its currency. But
(mainly advanced economies) the policy actions of the Fed. China’s current account surplus is now only 0.4 percent
The former was commonly justified by the need to build of GDP, heading toward slight deficit by 2022, and its re-
up foreign exchange reserves, as insurance against future serves have fallen from a peak of $4 trillion in 2014 to
crises, while the latter was justified by continued shortfalls about $3 trillion.
(often decimal point deviations) in meeting domestic infla- It is much more questionable to charge currency war-
tion targets. Whatever the rhetoric, the end result was global fare if there is no intervention, but depreciation nonethe-
monetary stimulus of unprecedented magnitude. less occurs as a consequence of monetary stimulus to an
Given this world of semi-fixed exchange rates, it is economy with high unemployment. Foreign complaints
also not surprising that the domestic imbalances first seen in 2010 that the United States was conducting a curren-
in the United States subsequently spread out globally. The cy war through quantitative easing missed the point that
ratio of global (non-financial) debt to global GDP has ac- recovery of the U.S. economy would boost U.S. imports
tually risen sharply since 2008, with low-quality corpo- from the rest of the world by more than associated easing
rate debt at the forefront. Concerns about future financial of the dollar would reduce them.
stability (and high house prices) now extend to important The U.S. current account deficit is no longer par-
emerging markets, not least China and India. Evidence of ticularly high. A key change is that, thanks to the frack-
resource misallocations and declining productivity growth ing revolution, the oil trade deficit has fallen from 2 per-
is increasingly widespread. These developments might cent of GDP in 2006–2012 and 1 percent in 2013–2015
not trigger another global downturn, but they will certain- to only 0.3 percent in 2016–2018. The International
ly exacerbate any downturn arising from other sources. Monetary Fund projects the current account deficit at 2.4
Against this backdrop of potential systemic insta- percent of GDP this year, virtually identical to the aver-
bility, and the trade war already initiated by the Trump age for 2010–2018 as well as the average projected for
administration, the prospect of explicit foreign exchange 2020–2024.
intervention by the U.S. authorities might seem relatively Nor is the dollar extremely high. The Federal
unimportant. Indeed, affected countries could always ne- Reserve’s broad real index is only 2 percent above the
gate its effects by retaliating in kind. Yet it is precisely this average for October 2016 to May 2019 and only 1 per-
prospect of monetary escalation that might finally lead cent above the January-February base used in the IMF’s
financial markets to start to look for cover from the even- benign projections. Although the real index stands 16 per-
tual inflationary implications. While it is impossible to say cent above its average 2006–2012 level, the 2 percent of
whether the dollar would rise or fall, many other financial GDP improvement on oil trade warrants a 12 percent ap-
markets seem overstretched. A sudden shift in perceptions preciation from that period. In part because of the decline
could have dangerous implications. in interest rates paid on U.S. debt held by foreigners, the
SUMMER 2019 THE INTERNATIONAL ECONOMY 25capital income surplus has risen by about 0.4 percent of If the world’s central bankers were to take any notice
GDP over the same period, justifying an additional 2 per- of Trump’s Twitter rhetoric, they would be in a state of
cent rise in the real exchange rate. permanent paralysis. As Olli Rehn, the current governor
President Donald Trump has accused the euro area of the Bank of Finland, noted a day later, euroland mon-
and China of manipulating their exchange rates lower. etary policy is set in accordance with the state of the euro-
Although the European Central Bank is indeed on the zone economy and not in order to alter the euro’s value on
verge of further monetary easing, the United States has the foreign exchanges.
also reversed its tightening. The gap between the ten-year In theory, the Federal Reserve could retaliate against
rate for U.S. Treasury bonds versus German bunds is actu- the European Central Bank by slashing the Fed funds
ally lower now (247 basis points at end-July) than a year rate and driving the dollar lower. But the Fed—like the
ago (252 basis points). European Central Bank—has for decades emphasized the
As for China, in the absence of the trade war there domestic requirements of the American economy in set-
would be little prospect of the currency falling below the ting interest rates. Coordinated attempts by the leading
sensitive threshold of ¥7 yuan per dollar (even though nations to manage exchange rates, such as the Plaza and
it has fallen from a peak of ¥6.1 in mid-2015 to ¥6.9 in Louvre accords in the mid-1980s, have been the excep-
June). China has ample reserves and no incentive to spur tion, not the rule, in high-level policymaking.
capital flight by allowing pronounced depreciation. The Serious students of international economics know that
trade war raises the risk that China will use depreciation currency manipulation adds nothing to a nation’s prosper-
as a form of retaliation, but that circumstance should not ity. The central banks of Argentina and Venezuela cannot
be conflated with a generalized currency war. teach the Fed or the European Central Bank about how
best to conduct monetary policy. But the Bundesbank—
still the intellectual powerhouse in European monetary
policy—does have lessons for everyone concerned about
taking the best policy decisions.
In the post-war decades, Germany belonged, like other
Currency industrial countries, to the Bretton Woods system of fixed
exchange rates. But in the early 1970s, the Bundesbank
manipulation adds became worried that American monetary policy was too
loose, particularly after the suspension (actually, the end)
nothing to a nation’s of the dollar’s convertibility into gold in August 1971. It
wanted to keep down the growth of the quantity of money
prosperity. in order to prevent inflation.
The Bundesbank realized that its actions would have
an impact on the foreign exchange markets, but gave prior-
ity to domestic price stability. In March 1973, it broke the
TIM CONGDON link with the dollar and allowed the deutschemark to find
Chairman, Institute of International Monetary Research, its own value against other currencies. The Bundesbank’s
University of Buckingham decision to let market forces work led to a sharp upward
movement in the deutschemark.
I
f currency depreciation were the key to boosting a na- German industrialists might have objected that the
tion’s international competitiveness, Argentina and more expensive deutschemark would handicap them in
Venezuela ought to be models of successful economic world markets, but they were relaxed about their interna-
policy. After all, the international values of the Argentine tional competitiveness and appreciated the value of low
peso and the Venezuelan bolivar are fractions of what they inflation to wider economic stability. They continued to
were a decade ago, and the devaluations must have given produce high-quality goods at acceptable prices, so that
an immense boost to their export industries. German exports grew with little interruption.
U.S. President Donald Trump complains that the lat- Further, German inflation stayed down, whereas in-
est easing of eurozone monetary policy—announced by flation in the United States (and Britain and Italy, and far
European Central Bank President Mario Draghi on June too many other countries, all with falling currencies on the
18, 2019—reduces the value of the euro against the dol- foreign exchanges) accelerated to intolerable levels.
lar and so constitutes unfair competition for American The Bundesbank’s commitment—then and later to
companies. But in truth, any easing of monetary policy domestic price stability—made it the world’s most ad-
by any central bank other than the U.S. Federal Reserve mired central bank in the second half of the twentieth
could have that effect. century.
26 THE INTERNATIONAL ECONOMY SUMMER 2019together account for another 13 percent of the U.S. trade
deficit, could be brought on board. Such an adjustment
It is time for an should reduce both U.S. trade deficits and the number of
Americans who view themselves as losers from free trade.
“Asian Plaza Although these four countries have various political issues
among themselves, working together may allow them to
Accord.” solve their trade problems with the United States, which is
one thing they have in common and which would be dif-
ficult to address individually.
In this forum, TIE has reminded its readers how bad
protectionist pressures were in the United States just before
the Plaza Accord was signed in September 1985, when the
RICHARD C. KOO exchange rate was 240 yen to the dollar. By the time the
Chief Economist, Nomura Research Institute, and author, Louvre Accord was signed in February 1987, the rate had
The Other Half of Macroeconomics and the Fate of fallen to 150 yen to the dollar and protectionism was no lon-
Globalization (2018). ger an issue in Washington. Instead of allowing the highly
unpredictable and arbitrary “tariff man” to run amok on
E
conomists have long preached that while free trade this trade imbalance problem, it would be far better for the
creates both winners and losers in a country, society surplus countries to jointly realign their exchange rates and
as a whole benefits because the winners’ gains are thereby safeguard the free trade system that has benefitted
far greater than the losers’ losses, especially when some them and the rest of the human race so much since 1945.
of the gains can be redistributed to the losers. What they
did not tell us, however, was that a nation’s trade account
must be largely balanced or in surplus for this conclusion
to be valid.
In the United States, which has been running massive
trade and current account deficits since the early 1980s, Currency wars no
the number of people counting themselves among the
losers from free trade has grown steadily. By November longer appear likely.
2016, this group had become large enough to elect the
openly protectionist Donald Trump as president. And this
was not just a Trump phenomenon: The Democratic Party
nominated Hillary Clinton to be its presidential candidate
in an arena filled with hundreds of signs saying “No to
TPP.” A world in which a generous United States helped
the global economy by purchasing foreign products and
running large trade deficits has proven itself to be no lon- ANDERS ÅSLUND
ger sustainable. Senior Fellow, Atlantic Council, and author, Russia’s
In the new and potentially conflict-ridden era we now Crony Capitalism: The Path from Market Economy to
find ourselves in, how the surplus countries who have Kleptocracy (2019)
benefitted from the U.S.-led free trade system respond
U
is absolutely crucial. If they want to avoid a 1930s-like .S. President Donald Trump is a true mercantilist
breakdown in global trade and maintain access to the U.S. straight out of the eighteenth century, having as little
market, they must act consciously and decisively to re- understanding of modern economics as of the rule of
duce the number of Americans who think they have been law. His emotional imposition of tariffs on countries and
hurt by free trade. products depending on his latest rage appears to be imped-
To meet this tall order, China, Japan, South Korea, ing international trade and thus global growth.
and Taiwan, which account for 60 percent of U.S. trade Since the 1980s, however, the global monetary sys-
deficits, should band together and revalue their currencies tem has changed so much that currency wars no longer
by 20 percent against the U.S. dollar in what might be appear likely. Two major changes have disarmed the mon-
described as an “Asian Plaza Accord.” By acting together, etary system. The weapons for a currency war are no lon-
they can push their currencies much higher than if they ger at hand.
acted individually because intra-Asian trade will not be af- The first change is that all major economies now have
fected. It would be even better if ASEAN countries, which floating exchange rates. A real currency war presupposes
SUMMER 2019 THE INTERNATIONAL ECONOMY 27that countries can devalue and set a lower exchange rate. and Louvre Accords, through which the G6 countries sta-
Today, few countries can do so. The biggest economy with bilized currency relationships in the mid-1980s, has given
a fixed exchange rate is probably Saudi Arabia. China way to a world where the major players have retreated into
controls its exchange rate, but it is not fixed. The very fortresses of self-serving protectionism? Despite commit-
weapon for a currency war is missing. Central banks can ments by the Group of 20 in 2013 to avoid currency wars
cut interest rates and pursue quantitative easing to debase entirely, a pledge reaffirmed by the leaders of the United
a country’s exchange rate, but it is so much less palpable States and China in 2016, a United Nations report of last
than a real devaluation of a currency. February reflected widespread concern that a bilateral trade
The other big change is the establishment of the eu- battle could spiral into more generalized currency wars.
rozone. In the early 1990s, big devaluations in Britain and How likely was such an escalation? The U.S. presi-
Italy brought havoc to the European Monetary System. dent has accused both China and the European Central
These violent devaluations were major reasons for the es- Bank of giving themselves “tremendous advantages” by
tablishment of the euro. Thanks to the euro, Italy is firmly weakening their currencies. And he is said to have urged
imbedded in the euro system and it can no longer devalue, labeling China as a currency manipulator during the 2016
while Britain has adopted a floating exchange rate, as have election cycle.
as all other major economies. In fact, the U.S. Treasury hadn’t declared China a
The problem is Trump’s inability to understand the currency manipulator since 1994, despite its unexpectedly
reasons for the patently large U.S. current account defi- sharp devaluation in 2015. More recently, China has actu-
cit. The first reason is that the U.S. dollar is the world’s ally been propping up its currency, presumably to head
dominant reserve currency, accounting for almost two- off U.S. retaliation against alleged deliberate weakening
thirds of international currency reserves. That means that of the yuan. This behavior led me to believe that other
the United States has a chronic current account deficit of countries would be equally cautious in regard to currency
perhaps $300 billion each year. valuations, while the American president had apparently
The other reason for the large U.S. current account opted for tariffs as the chosen weapon with which to pres-
deficit is the vast U.S. federal budget deficit of nearly $1 sure other countries into doing his bidding.
trillion, although the United States has effectively full It required only seventy-two hours to prove me wrong.
employment. Much of those funds can only flow abroad. On August 1, President Trump announced that, because
Increased tariffs cannot reduce the current account deficit. U.S.-China trade negotiations had broken down, he would
They can only redistribute that deficit to other countries. impose a 10 percent tariff on some $300 billion of Chinese
goods, in addition to the 25 percent tariffs already placed on
some $200 billion of Chinese exports to the United States.
On the following Monday, China sent a retaliatory signal by
Although a tariff allowing the yen to fall below 7 per dollar, a level that had
served as a floor for more than a decade.
spat could in The President furiously accused China of gaining an
unfair competitive advantage through currency manipula-
principle remain tion, and the U.S. Treasury followed suit by formally declar-
ing China a deliberate manipulator, a symbolic but insulting
bilateral, a currency designation. In fact, China gave a credible response that the
yen’s new value was still higher than market forces alone
war is almost certain would dictate, and indicated that it would not be allowed to
fall to a market-determined level. This drop in value of less
to spread. than 1 percent jolted stock markets and signaled that, by
adding a currency dimension to an ongoing trade battle, the
MARINA V.N. WHITMAN threat to global growth was gaining strength.
Professor, Business Administration & Public Policy, Although a tariff spat could in principle remain bi-
Gerald R. Ford School of Public Policy, University of lateral if the participants are willing to ignore trade dis-
Michigan, and former member, President’s Council tortions and GATT/WTO rules, a currency war is almost
of Economic Advisors certain to spread. Countries that compete with China as
exporters are bound to find themselves at a new disad-
U
ntil the first week in August, I thought that an escala- vantage unless they allow their currencies to weaken in
tion of current trade tensions into widespread curren- step with that of their enormous competitor. Many south-
cy wars was unlikely. Why such optimism, when the east Asian countries are particularly vulnerable, but other
spirit of international cooperation that produced the Plaza BRICS and emerging markets may feel threatened as well.
28 THE INTERNATIONAL ECONOMY SUMMER 2019You can also read
