Currency wars flare up from time to time, usually during moments of economic tumult. They typically involve countries jockeying for a competitive export edge by driving down their currencies. What’s less common is a so-called reverse currency war. But it’s possible that one could be brewing, whether as the result of deliberate policies or as a side effect of steps central banks are taking to fight inflation. In particular, the sharp rise in the value of the dollar as the US Federal Reserve pursues its most aggressive interest-rate hikes in almost 30 years is posing challenges to currencies and central banks around the world.
1. What’s a currency war?
If a country’s currency falls in relation to other currencies, that can help its economy. Its exports become cheaper relative to competitors, boosting demand from abroad, while higher import prices spur domestic consumption of more homegrown products and services. And both of these provide support to local producers. A round of competitive devaluations is thought to have deepened the Great Depression that began in 1929, with countries leaving the then-prevalent gold standard to weaken their currencies. In the early years of this century, the US and other rich countries complained that China was depressing the value of its currency, the yuan, to increase exports. But the phrase “currency war” was only popularized around 2010, when Brazil’s then-finance minister, Guido Mantega, accused wealthier nations of devaluing their currencies to stimulate economies still reeling from the financial crisis of two years before.
2. What’s a reverse currency war?
A situation in which countries work to make their currency stronger. Rather than boosting growth, the goal of any such move is to help tame inflation, since a stronger currency means that imports are relatively cheaper. The Fed’s actions have boosted the US dollar, driving up Bloomberg’s gauge of greenback strength by close to 7% this year. On the flipside, the euro -- which is used by more than 300 million people in Europe -- has fallen to a five-year low against the greenback, while the British pound and a majority of other important currencies have slumped too.
3. Does a stronger currency really curb inflation?
Currency strength does weigh on inflation but just how much is both debatable and subject to change, depending on circumstances. The degree to which exchange rate changes affect core inflation -- which excludes volatile factors like food and energy -- is called the pass-through rate. In some previous bouts of dollar strength, that rate’s been marginal. But some, such as Citigroup Inc. chief economist Nathan Sheets, argue that it could be higher during times of elevated inflation. In 2020, when inflation was subdued, a 10% increase in the value of the dollar would have been expected to dampen increases in the consumer price index by only about half a percentage point. But at the current pace of inflation, which has been fueled in large part by higher commodity costs, the pass-through coefficients could be more than double that, approaching a full percentage point, said Sheets, who previously worked for the US Treasury and Federal Reserve.
4. What are central banks saying about this?
Most central banks seek to steer their economy through a combination of interest-rate changes and balance-sheet actions, and are usually wary of doing or saying anything that could be construed as trying to manage exchange rates directly. The US Treasury can (and has at various times) labeled some trading partners as currency manipulators if it believes they’re trying to gain an unfair advantage. The Fed, for its part, emphasizes that its goal in raising interest rates is to fight inflation by curbing demand rather than bolstering the dollar. Fed Chair Jerome Powell has said that the central bank’s commitment to price stability has strengthened confidence in the dollar as a store of value. Yet while most of the Fed’s major global counterparts have historically tended to walk a similar tightrope around currency issues, some are becoming more vocal about the link between exchange rates and inflation.
5. What’s different?
One sign of how things have changed recently is that some central banks previously known for using direct foreign-exchange intervention to weaken their currencies are now doing the opposite. The Swiss National Bank, which historically has acted in currency markets to weaken the franc, has allowed its currency to strengthen this year and said in June it would consider selling foreign currency if it weakened excessively. “We let the Swiss franc appreciate,” SNB President Thomas Jordan said in March. “This is one of the reasons why in Switzerland inflation is lower than compared to the euro zone or the United States.” European Central Bank official Francois Villeroy de Galhau, meanwhile, has said that a euro which is “too weak” would go against that monetary authority’s price-stability objective, and in the UK, the Bank of England’s Catherine Mann went even further by highlighting how a faster pace of tightening could support the pound.
6. Are there winners and losers?
Consumers from the countries that successfully rally their currencies are the clear winners during a reverse currency war, with domestic prices tempered slightly due to greater buying power. But there are plenty of losers, including multinational corporations, nations that rely on exports and emerging economies. US companies ranging from Salesforce Inc. to Costco Wholesale Corp. have raised complaints about the surging dollar on recent earnings calls. That’s because a stronger greenback lessens the value of those companies’ foreign revenue when translated back into dollars. It also makes their products less competitive as prices rise in local currency terms, reducing demand. For developing economies, there’s the risk that a “currency mismatch,” which takes place when governments, corporations or financial institutions have debt in US dollars but pay in a depreciating local currency, can push them into financial jeopardy.
7. Who isn’t joining the party?
With a nose-diving currency, Japan appears to be playing by the currency war’s old rules. Bank of Japan Governor Haruhiko Kuroda has kept yields anchored to the floor in an effort to stimulate the economy. In the process, the yen has fallen precipitously, dropping more than 15% this year against the US dollar -- the biggest drop of any Group-of-10 currency. In mid-June, ahead of the BOJ’s most recent policy meeting, Kuroda shifted his stance slightly, signaling that the central bank was watching the currency, in a rare departure from the status quo of staying mum on the country’s exchange rate. He conceded that the yen’s abrupt slide wasn’t advantageous for the country’s economy, though the bank didn’t alter policy settings.
• Bloomberg Opinion’s John Authers on Lehman-era precedents for the current market rout and how central bank actions are different this time around.
• The Bank of England’s Catherine Mann explains how interest rates elsewhere can spill over to affect the UK economy.
• QuickTakes on why Japan’s yen is so weak and on the many risks that emerging market countries are facing.
• Bloomberg Intelligence on whether the US faces a return to 1970s stagflation, and the difficulty of nailing a soft landing.
• University of California, Berkeley economist Barry Eichengreen on old-school currency wars.
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