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  • Heng Kim
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A Primer on Currency Wars

2016-09-30 10:52:13

Currency war occurs when a nation devalues the value of its currency to bolster their economy, specifically exports. Also known as competitive devaluation, it is common in the forex market but doing it intentionally is another story.



This is what happens when countries start using different monetary policy tools to deliberately lower the worth of the currency. A weak currency makes imports more costly and exports more competitive in global markets. Higher export volumes ignite economic growth, while more expensive imports may render the same effect since consumers look for local alternatives to imported goods. Better terms of trade is tantamount to better GDP growth, higher employment rate, and lower current account deficit (or greater current account surplus). Monetary policies that weaken a currency may improve capital and housing markets, which in turn boost consumption.



There are various factors and reasons for currency devaluation. No nation wants a strong currency as they find it counter-intuitive; hence, such a move. But traders should note currency appreciation or depreciation will only prevail in the medium- to long-term in case it is justified.



What happens when countries start employing various monetary policy tools to deliberately lower the worth of the currency. There are various reasons for depreciating a currency. No nation wants a strong currency as they find it counter-intuitive. The Brazilian real, for instance, has lost 48% of its value since 2011. The country depreciated its value but failed to counter other problems. One notable example is when China devalued the yuan last year. As a result, the economy degenerated primarily because of massive capital outflows.



Currency depreciation in many parts of the globe results in currency wars. Depending on the prevailing situation, it can be beneficial or threatening. It can boost the currency market or aggravate currency volatility, which can fuel hedging costs for entities and impact foreign investments.