Wars are not always fought with guns – but they are always fought with money. Last Thursday, U.S Federal Reserve Chairwoman Janet Yellen announced that there will not be an interest rate hike, which in turn helped buoy the markets for the day. But this move could potentially initiate a currency war, at least according to CNBC. The problem with CNBC’s assertion is the claim that it might set off a currency war…when in reality we are already in the middle of one.
Janet Yellen
Interest Rate and Currency War: What Are They?
Interest rates are a fee that a debtor pays on the amount of money they want to borrow from a creditor. Essentially it is the premium or cost to borrow money. The interest rate, perhaps one of the most significant tools in the monetary arsenal of central banks, can help combat inflation, unemployment, and a weak economy. Since the Great Recession, the Federal Reserve, the closest thing to a central bank in the US, has been cutting interest rates to basically zero. It is essentially free to borrow money in the US. Thursday’s announcement by Chairwoman Yellen signaled that the US will continue to intervene in its markets to ensure it can help stimulate it back to a stronger level. As a result of the government’s inaction with respect to interest rates, the dollar hit its lowest value against other major currencies in weeks. But such intervention will send a reverberation across global markets. Other countries will react accordingly.
Central banks across the globe will attempt to retaliate with similar actions of economic stimulation. This tit for tat in economic retaliation, which has been going on since 2008, is what already sparked the currency war we are mired in. A currency war is an international condition when countries contest with one another to achieve the lowest exchange rate for their currency.
So What Does it Mean?
By achieving the lowest exchange rate, a nation can ensure they can boost their exports and reduce their imports. This does not only help boost the economy but reduce reliance on foreign goods while increasing employment domestically. This is the ideal situation, but almost always it does not end up that way. Instead the goal of devaluation is a very risky strategy and nearly every time backfires. The currency wars typically end up reducing the standard of living and making it much more expensive to travel abroad.
Caught in the Crossfire: Emerging Markets
Typically with all wars, there are losers and winners. In currency wars, almost everyone, voluntary or involuntarily, becomes a participant. Unfortunately, emerging markets typically lack the wherewithal to stand a strong economic defense in such wars. Emerging markets become the unintended causalities that get caught up in the middle of the crossfire by the larger economies waging the war. The exporting industries of these nations will come to a halt since it will be relatively more expensive than the domestic products of the larger economies engaging in the “war”. Typically emerging markets have a large segment of their economy focused on manufacturing and shipping. As a result, the growths of these developing economies become stagnant and reverse into recession.
What’s Next?
CNBC believed that it might start a currency war. In reality, we have had an ongoing currency war since the Great Recession in 2008. There has been continuous devaluation by different governments in order to prop up their economies that nearly collapsed after that fiasco.
In the US, the favorite tools have been the interest rate and quantitative easing. Following in step, many nations in Europe and Japan have followed suit. Unlike nations with a free floating currency, China has directly devalued its currency by pegging the value of the Yuan (also known as the Reminbi) lower to the dollar.
With this latest US move in the ongoing currency war, the ball is now in China’s court to take action. What the future holds nobody knows but most likely another set of government intervention by the Chinese government will come to further devalue their currency. The result will be further destabilization to emerging markets and a bleak future for all.
