A currency war is really unwinnable these days
IT’S BEEN a year since a sudden 1.9 percent decline in the Chinese yuan rattled global markets and prompted fears of a global currency war. China has mostly soothed nerves by moderating the renminbi’s swoon since then. But what should really put minds to rest is the knowledge that no one – not even China, which arguably did power its rise, at least in part, on the back of an artificially depressed yuan – could win a true currency war today.
The temptation to gain an advantage over competitors with a cheaper currency hasn’t diminished, of course. First and foremost, devaluation holds out the promise of boosting exports by making them less expensive. Where a country has substantial external borrowing in its own currency, a weaker currency also engineers a transfer of wealth from foreign savers, as the value of those securities falls in dollar terms. Devaluation may also stimulate inflation as the higher cost of imported products pushes up price levels.
In recent years, governments have refrained from intervening directly in currency markets, preferring to use monetary policy to help drive down the value of their currencies. These policies – on display most notably in Japan and Europe – are supposedly intended to increase demand. But households and companies have proven reluctant to borrow more to finance consumption or investment. Instead, low and in some cases negative rates have served to reduce the cost of servicing debt and, by encouraging capital flight, to create pressure on the currency.
No guarantees
It’s not clear, however, that this strategy of implicit devaluation can achieve any wider benefits. For one thing, a weaker currency no longer guarantees an increase in exports.
External demand remains sluggish because of the slowdown in global growth. Trade growth has slowed down sharply since 2014.
Moreover, the complexity of today’s global supply chains, with production spread across multiple countries, undermines the advantages of a weakened currency. When the yen was strong, Japanese car makers relocated plants to cheaper locations abroad; they’re not going to move those factories back home unless convinced that the yen isn’t going to strengthen once again. Recent estimates from the World Bank suggest that falling currencies were only half as effective in increasing exports between 2004 and 2012 as they were in the prior eight years.
In many countries, exports matter much less than before. The US in particular is relatively self-contained, with imports and exports together accounting for about 20 percent of gross domestic product. While Europe is more exposed to trade, most takes place within the freetrade area, where many nations share a single currency. China’s external exposure is complex as it now acts mostly as a manufacturing or assembly hub, using domestic labour to convert imported components into intermediate or finished products. A lower yuan thus has less impact on economic activity than previously.
Key sectors such as advanced manufacturing, information technologies, pharmaceuticals and entertainment are less likely to be affected by currency moves due to high intellectual property content, limited competition and the prevalence of long-term contracts. Services, which play an increasingly important role in China and elsewhere, are mostly local: One in four US manufacturing jobs is linked to trade, whereas only about 6 percent of jobs in services are similarly affected.
And countries have got better at defending against artificially cheapened goods. They now deploy a range of covert trade restrictions. Many offer subsidies and preferential financing to domestic manufacturers.
Finally, it’s important to remember that other factors may offset any advantages gained from devaluation. Currency volatility and uncertainty tend to discourage long-term business investment. A weaker currency also reduces the purchasing power of citizens. The euro has lost over 30 percent of its value against the dollar since 2011, effectively slashing the income and wealth of euro zone consumers.
A currency war is winnable only if a single country devalues. Every nation can’t by definition have the cheapest currency. That doesn’t mean countries won’t try to gain an advantage but their chances of succeeding are lower than ever. – Bloomberg