Do Currency Wars Drive World Economies?

AMA4-17-15The major powers may rattle sabers and troops and weapons may move in places all around the globe, but there’s another, quieter kind of war that has the power to make or break economies. Global “currency wars” like the one we’re In right now affect rates of exchange, inflation, and the flow of goods and services everywhere in the world.

Currency wars come around periodically in the interconnected world of global finance, where what one country decides to do with its currency affects the monetary policy of another one thousands of miles away.

The current currency war has been going on for a few years now according to some financial and economic experts, who place its start somewhere in 2010. It made headlines in early 2015 when Switzerland abruptly decided to abandon its longstanding cap on the valuation of its franc.

Without the Swiss National Bank’s firm limits on the franc, it could float freely relative to other currencies, particularly the euro. The SNB’s decision came as the Eurozone was planning to launch a round of quantitative easing for the euro – putting more euros into circulation in order to stimulate spending.

The Swiss move caused economic upheaval at home and in neighboring countries holding franc-denominated debt. The rush was on to buy up more currency to back the debt, and the fallout rippled as far as the United States, with losses by major banks with heavy involvement in international currency trading.

Although the duel of the franc and euro made financial headlines and put the concept of currency wars into the public arena, currency wars have a long history. As a new article from Business Insider reports, there have been three of them in the last century or so alone. And they’ve changed the way the world does business every time.

What is a currency war anyway? Basically, it’s a race among nations to cheapen currency –just as price war among retailers is won by the one who can cut prices the lowest and still make money. In the world of monetary policy, cheapening currency can boost exports and keep those exports more competitive internti0onlaly.

A strong currency – like the dollar, let’s say – actually makes international commerce tougher, since an item costs buyers from places with weaker currencies more to make the purchase. While these cheaper currencies may encourage trade, they can also raise the prices of goods and services at home, providing fuel for a round of inflation and increased prices for everyday goods.

In the twentieth century, currency wars have lasted anywhere from five to fifteen years, with varying effects. The first of these came in 1921, when Germany completely devalued its currency in the aftermath of World War 1. Within a few years, France and Belgium had followed suit.

That launched a series of currency wars leading up to the present one, driven largely by the shift away from the gold standard that began in 1914 when the whole world went to war. Before World War I, the balance between gold and paper money remained steady. But in the war years, more money was needed – and that shifted the balance between gold and paper money.

That started the pattern of systematically devaluing currency during certain economic conditions. Successive currency devaluations by the world’s great powers in the periods between the two World Wars led to severe depressions and currency crises. The next currency war came in 1967 and lasted twenty years and spawned three major recessions.

The latest currency war began in 2010 and, as the Swiss demonstrated in their actions regarding the franc, it’s still going on. And if past currency wars are any indication, this one will likely last awhile. Thanks to a strong dollar and the disintegration of the old gold standard, the coming years promise uncertainty and constant change.

Currency wars aren’t won with guns and tanks, but with banknotes and policies. And for wise investors hoping to protect assets, the current skirmishes are worth watching.  (Top image:flickr/rieh)

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The American Monetary Association Team

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