ACKNOWLEDGEMENT

I would like to thank my teacher Ms. Vrinda Jayaprakash, who gave me the opportunity and
guidance to take up and complete this project, it provided me with a scope to learn and
understand the topic ‘Currency War’ and gave me pleanty insight on various topics linked to it,
this project also helped in furthering my knowledge

I would also like to express my humble gratitude to my friends and family members who
supported me who helped my completing the project given at hand.
INDEX

1. Cover Page
2. Certificate
3. Acknowledgement
4. Index
5. Objectives
6. Introduction
7. Mechanisms Of Devaluation
8. Historical Overview
9. Impact On Other Countries
10. And Other Outlooks
11. Currency Manipulation
12. Case Study
13. Conclusion
14. Biblography
OBJECTIVES

1. to preserve the height of nominal wage rates or even to create the conditions enquired for
their further increase, while real wage rates should rather link.
2. To make commodity prices, especially the prices of farm products, rise in terms of
domestic money or, at least to check their further drop.
3. To favor the debtors at the expense of creditors.
4. To encourage exports and to reduce imports.
5. To attract more foreign tourists and to make it more expensive for the country oven
citizens to visit foreign countries.
INTRODUCTION

Currency ware also known as competitive evaluation is a condition in international affairs where
countries seek to gain a trade advantage by causing the exchange rate of their currency to fall in
relation to other countries currency. As the exchange rate of a country's currency. As it falls,
exports become more competitive in other countries, and imports into the country become more
expensive Both effects benefit the domestic industry and thus employment which receives a
boost in demand from both domestic and foreign markets. However, the price increases for
import goods (as well as in the cost of foreign travel) are unpopular as they harm citizen's
purchasing power when all countries adopt a similar strategy it can lead to a general decline in
international trade harming all countries.

Historically competitive devaluations have been rare as countries have generally preferred to
maintain a high value for their currency. Countries that have generally allowed market forces to
work have participated in systems of managed exchange rates. An exception occurred when a
currency war broke out in 1930 when countries abandoned the gold standard during the Great
Depression and used currency evaluation in an attempt to stimulate their economies. Since this
effectively pushes unemployment overseas, trading partners quickly retaliated with their own
devaluation. the period is considered to have been an adverse situation for all concerned, an
unpredictable change in exchange rates reduced overall international trade

According to Guido Mantega, former Brazilian Minister of Finance a global currency war broke
out in 2010. This view was echoed by numerous other government officials and financial
journalists who suggested the phrase "currency war" related to the extent of hostility. With a few
exceptions such as Mantega, even commentators who argued there had been a currency war in
2010 generally concluded that it had fizzled out by mid-2011 States engaging in possible
competitive devaluation since 2010 have saved a mix of policy tools, including direct
government intervention, the imposition of capital controls and indirectly quantitative easing
while many countries experienced undesirable upward pressure on their exchange rates and took
part in the ongoing arguments, the most notable dimension of the 2010-11 episode was the
rhetorical conflict between the United States and China over the valuation of the yuan. In
January 2013, measures announced by Japan which were expected to devalue its currency
sparked concern of a possible second 21st-century currency wavy breaking out this time with the
principal source of a tumour being not China versus the US, but Japan versus the Eurozone. By
late February concerns of a new outbreak of currency, and war had been mostly allayed after the
G17 and G20 issued statements committing to avoid competitive devaluation. After the
European Central Bank launched a fresh programme of quantitative easing in January 2015,
there was once again an intensification of discussion about a currency war.
Mechanisms Of Devaluation

A state wishing to devalue or at least check the appreciation of its currency must work within the
constraints of the prevailing International monetary system. During the fq 30s, countries had
relatively more direct control over their exchange rates through the actions of their Central Bank
Bretton Wood system in the early 1970s, market substantially increased in influence, with
market forces largely setting exchange rates you an increasing number of countries. However,
the states central bank can still intervene in the markets to effect a devaluation if it sells its own
currency to buy other currencies then this will cause the value of its own currency to fall a
practice common with states that have a managed exchange rate regime, less directly,
quantitative easing Common in 2009 and 2010, tends to lead to a fall in the value of the currency
even if the central bank does not directly by any foreign assets.

A third method is for authorities simply to talk down the value of their currency by hinting at
future action to discourage speculators from betting on a future rise, though sometimes this has a
little discernible effect. Finally, a central bank can effect a devaluation by lowering its base rate
of interest; however this sometimes has limited effect, and, since the end of World War II, most
central banks have set their base rate according to the needs of their domestic economy.

If a country's authorities wish to devalue or prevent appreciation against market forces exerting
upwards pressure on the currency, and retain control of interest rates, as is usually the case, they
will need capital controls in place—due to conditions that arise from the impossible trinity
trilemma.
Historical Overview

Up to 1930

For millennia, going back to at least the classical period governments have often devalued their
currency by reducing its intrinsic value. Methods have included reducing the percentage of gold
in coins or substituting less precious metals for gold. However, until the 19th century, the
proposition of the world treacle that occurred between nations was very low, so exchange rates
weres not generally a matter of great concern. Rather than being seen as a means to help
exporters, the debasement of a currency war was motivated by a desire to increase the domestic
money supply and the ruling authorities' wealth through seigniorage, especially when they
needed to finance word ou pay debts. A notable example is the eubulauteal devaluators which
occurred during the Napoleonic wars when nations wished to compete economically they
typically protested mercantilism

Currency war in the Great Depression

During the Great Depression of the 1930s, most countries abandoned the gold standard With
widespread high unemployment, devaluation become common, a policy that has frequently been
described as "beggar thy neighbour in which countries purportedly compete to export
unemployment. However, because of the effects of a devaluation and in many cases retaliatory
tariffs and other barriers by trading partners, few nations would gain an enduring advantage

The three principal parties were Britain, France and the United States for most of 1920 the three
generally had coinciding interests; both Us and France supported Britain's efforts to raise
sterlings value against market forces

Bretton Woods era

From the end of World War II until about 1971, the Bretton words system of semi-fixed
exchange rates meant that competitive devaluation was not an option, which was one of the
design objectives of the architects of the system Additionally, global growth was generally way
high in this period so there was little incentive for currency way even if it had been possible.

1973 to 2000

While some of the conditions to allow a currency war were in place at various points throughout
this period, countries generally had contrasting priorities and at no point were there enough states
simultaneously wanting to devalue for a currency war to break out. On several occasions,
countries were desperately attempting not to cause a devaluation but to prevent one. So states
were striving not against other countries but against market forces that were exerting undesirable
downwards pressure on their currencies. Examples include The United Kingdom during Black
Wednesday and various tiger economies during the Asian crises of 1997. During the mid-1980s
the United States did desire to devalue significantly but was able to secure the cooperation of
other major economies with the Plaza Accord. As free market influences approached their zenith
during the 1990s, advanced economies and increasingly transition and even emerging economies
moved to the view that it was best to leave the running of their economies to the markets and not
to intervene even to correct a substantial current account deficit.

2000 to 2008

During the 1997 Asian crisis, several Asian economies ran critically low on foreign reserves,
leaving them forced to accept harsh terms from the IMF, and often to accept low prices for the
forced sale of their assets. This shattered faith in free market thinking among emerging
economies, and from about 2000 they generally began intervening to keep the value of their
currencies low. This enhanced their ability to pursue export-led growth strategies while at the
same time building up foreign reserves so they would be better protected against further crises.
No currency war resulted because on the whole advanced economies accepted this strategy—in
the short term it had some benefits for their citizens, who could buy cheap imports and thus
enjoy a higher material standard of living. The current account deficit of the US grew
substantially, but until about 2007, the consensus view among free-market economists and
policymakers like Alan Greenspan, then Chairman of the Federal Reserve, and Paul O'Neill, US
Treasury secretary, was that the deficit was not a major reason for worry.

This is not to say there was no popular concern; by 2005 for example a chorus of US executives
along with trade unions and mid-ranking government officials had been speaking out about what
they perceived to be unfair trade practices by China. These concerns were soon partially allayed.
With the global economy doing well, China was able to abandon its dollar peg in 2005, allowing
a substantial appreciation of the Yuan up to 2007, while still increasing its exports. The dollar
peg was later re-established as the financial crises began to reduce China's export orders.

Economists such as Michael P. Dooley, Peter M. Garber, and David Folkerts-Landau described
the new economic relationship between emerging economies and the US as Bretton Woods II.

Competitive devaluation after 2009

By 2009 some of the conditions required for a currency war had returned, with a severe
economic downturn seeing global trade in that year decline by about 12%. There was a
widespread concern among advanced economies about the size of their deficits; they increasingly
joined emerging economies in viewing export led growth as their ideal strategy. In March 2009,
even before international co-operation reached its peak with the 2009 G-20 London Summit,
economist Ted Truman became one of the first to warn of the dangers of competitive
devaluation. He also coined the phrase competitive non-appreciation. On 27 September 2010,
Brazilian Finance Minister Guido Mantega announced that the world is "in the midst of an
international currency war." Numerous financial journalists agreed with Mantega's view, such as
the Financial Times' Alan Beattie and The Telegraph's Ambrose Evans-Pritchard. Journalists
linked Mantega's announcement to recent interventions by various countries seeking to devalue
their exchange rate including China, Japan, Colombia, Israel and Switzerland.
Martin Wolf, an economics leader writer with the Financial Times, suggested there may be
advantages in western economies taking a more confrontational approach against China, which
in recent years had been by far the biggest practitioner of competitive devaluation. Although he
advised that rather than using protectionist measures which may spark a trade war, a better tactic
would be to use targeted capital controls against China to prevent them buying foreign assets in
order to further devalue the yuan, as previously suggested by Daniel Gros, Director of the Centre
for European Policy Studies.

As investor confidence in the global economic outlook fell in early August, Bloomberg
suggested the currency war had entered a new phase. This followed renewed talk of a possible
third round of quantitative easing by the US and interventions over the first three days of August
by Switzerland and Japan to push down the value of their currencies. In September, as part of her
opening speech for the 66th United Nations Debate, and also in an article for the Financial
Times, Brazilian president Dilma Rousseff called for the currency war to be ended by increased
use of floating currencies and greater cooperation and solidarity among major economies, with
exchange rate policies set for the good of all rather than having individual nations striving to gain
an advantage for themselves.

Currency war in 2013

In mid January 2013, Japan's central bank signaled the intention to launch an open ended bond
buying programme which would likely devalue the yen. This resulted in short lived but intense
period of alarm about the risk of a possible fresh round of currency war.

In early February, ECB president Mario Draghi agreed that expansionary monetary policy like
QE have not been undertaken to deliberately cause devaluation. Draghi's statement did however
hint that the ECB may take action if the Euro continues to appreciate, and this saw the value of
the European currency fall considerably. A mid February statement from the G7 affirmed the
advanced economies commitment to avoid currency war. It was initially read by the markets as
an endorsement of Japan's actions, though later clarification suggested the US would like Japan
to tone down some of its language, specifically by not linking policies like QE to an expressed
desire to devalue the Yen.

From March 2013, concerns over further currency war diminished, though in November several
journalists and analysts warned of a possible fresh outbreak. The likely principal source of
tension appeared to shift once again, this time not being the U.S. versus China or the Eurozone
versus Japan, but the U.S. versus Germany. In late October U.S. treasury officials had criticized
Germany for running an excessively large current account surplus, thus acting as a drag on the
global economy.

Currency war in 2015

A €60bn per month quantitative easing programme was launched in January 2015 by the
European Central Bank. While lowering the value of the Euro was not part of the programme's
official objectives, there was much speculation that the new Q.E. represents an escalation of
currency war, especially from analysts working in the FX markets. David Woo for example, a
managing director at Bank of America Merrill Lynch, stated there was a "growing consensus"
among market participants that states are indeed engaging in a stealthy currency war. A Financial
Times editorial however claimed that rhetoric about currency war was once again misguided. In
August 2015, China devalued the yuan by just under 3%, partially due to a weakening export
figures of −8.3% in the previous month. The drop in export is caused by the loss of
competitiveness against other major export countries including Japan and Germany, where the
currency had been drastically devalued during the previous quantitative easing operations. It
sparked a new round of devaluation among Asian currencies, including the Vietnam dong and
the Kazakhstan tenge.

Comparison between 1932 and 21st-century currency wars

Both the 1930s and the outbreak of competitive devaluation that began in 2009 occurred during
global economic downturns. An important difference with the 2010s is that international traders
are much better able to hedge their exposures to exchange rate volatility because of more
sophisticated financial markets. A second difference is that the later period's devaluations were
invariably caused by nations expanding their money supplies by creating money to buy foreign
currency, in the case of direct interventions, or by creating money to inject into their domestic
economies, with quantitative easing. If all nations try to devalue at once, the net effect on
exchange rates could cancel out, leaving them largely unchanged, but the expansionary effect of
the interventions would remain. There has been no collaborative intent, but some economists
such as Berkeley's Barry Eichengreen and Goldman Sachs's Dominic Wilson have suggested the
net effect will be similar to semi-coordinated monetary expansion, which will help the global
economy. James Zhan of the United Nations Conference on Trade and Development
(UNCTAD), however, warned in October 2010 that the fluctuations in exchange rates were
already causing corporations to scale back their international investments.
Impact On Other Countries

The G-Cubed (G20) model is a multi-country, multi-sector, intertemporal general equilibrium

model. It is designed to bridge the gaps between three areas of research—econometric general
equilibrium modeling, international trade theory, and modern macroeconomics—by
incorporating the best features of each. There are many versions of the model that have been
developed over many years- each designed to address a particular question. The version
presented in this paper is designed specifically to study the G-20 and the implications of its
policy agenda. Previous versions of GCubed have been used to study a range of policy areas,
including macroeconomic cooperation, international trade, monetary policy, fiscal policy, tax
reform, and environmental regulation. Studies have shown the effectiveness of G Cubed in
explaining the adjustment process in many historical episodes, including Reaganomics, German
reunification, European fiscal consolidation in the 1990s, the formation of NAFTA, and the
Asian financial crisis. G-Cubed has also proven successful in helping to explain the “six major
puzzles in international macroeconomics” highlighted in Obstfeld and Rogoff (2000). It has also
proven useful in understanding the 2009 Global Financial Crisis. The G-Cubed (G20) model
represents the world as 24 autonomous blocks: one for each G-20 economy (including the rest of
the eurozone) and four regions which represent the world’s nonG-20 economies. These regions
are: the other economies of the OECD; the other economies of Asia; the other oil-producing
economies; and a catch-all “rest of the world”. Each region in G-Cubed is represented by its own
multi-sector econometric general equilibrium model with highly disaggregated, multi-sectoral
flows of goods and assets between them. Each region has six industries, which correspond to the
production of six goods: energy, mining, agriculture (including fishing and hunting), durable
manufacturing, non-durable manufacturing, and services. Each good in a region is an imperfect
substitute for goods from other regions. Thus, there are effectively 144 goods.

Each country consists of 6 representative firms, a representative household, and a government.

The model also includes markets for goods and services, factors of production, money and
financial assets (bonds, equities, and foreign exchange). Finally, each country interacts through
the flows of goods and assets. Some of the key features of the G-Cubed

(G20) model are: • Specification of the demand and supply sides of economies. • Integration of
real and financial markets of these economies with explicit arbitrage linking real and financial
rates of return. • Inter-temporal accounting of stocks and flows of real resources and financial
assets. • The imposition of inter-temporal budget constrains so that agents and countries cannot
borrow or lend forever without undertaking the required resource transfers necessary to service
outstanding liabilities. • Short-run behavior is a weighted average of neoclassical optimizing
behavior based on expected future income streams and Keynesian current income. • The real side
of the model is disaggregated to allow for the production of multiple goods and services within
economies. • International trade in goods, services, and financial assets. • Full short-run and
long-run macroeconomic closure with macro-dynamics at an annual frequency around a long-run
Solow-Swan-Ramsey neoclassical growth model. • The model is solved for a full rational-
expectations equilibrium (consisting of a mix of rational and rule of thumb agents) at an annual
frequency from 2015 to 2100.
Global Economy and Development The rules for monetary and fiscal policies in the model are
important for the results. Central banks in each economy follow a Henderson-McKibbin-Taylor
rule with weights in different countries on output growth relative to trend, inflation relative to the
target, and in some case weights on nominal exchange rates relative to a target. Some countries
such as Saudi Arabia peg exactly to the U.S. dollar so the weights on inflation and output growth
are zero, and the weight on the exchange rate is very large. Other countries such as China follow
a crawling peg with some weight on inflation and the output gap but an additional weight on
change in the Yuan/U.S. dollar exchange rate. Within the eurozone, a single central bank sets
monetary policy with weights on euro zone-wide output growth relative to the target and euro
zone-wide inflation. The nominal policy interest rate is equal across Germany, France, Italy and
the rest of the eurozone. The model documentation in McKibbin and Triggs (2018) contained
further details. The fiscal rules followed by each country are standardized across countries.
Government spending is a constant share of baseline GDP with tax rates on households and firms
and tariff rates of trade constant at the rates in 2015. There is a lump-sum tax on households that
changes in response to changes in the interest payments on government debt. The fiscal closure
is called an incremental interest payments rule in McKibbin and Sachs (1991). Budget deficits
are endogenous given these assumptions, but fiscal sustainability is assured by the fiscal rule
which sets lump-sum taxes equal to the change in servicing costs on government debt. After a
shock, in the long run, the stock of debt to GDP will stabilize at a level equal to the long-run
primary fiscal deficit divided by the real growth rate of the economy. The fiscal closure
assumption implies that a fall in productivity will lead to a permanently higher stock of
government debt to GDP and a rise in productivity will lead to a permanently lower stock of debt
to GDP. Alternative fiscal closures can significantly change the results in this paper. Future
research will explore the interaction of the fiscal closure assumption and changes in productivity
growth. The following simulations elaborate some of these key features of the model, and further
details are available in McKibbin and Triggs (2018).

Modeling a G-20 currency war The above analysis showed that the U.S. real effective exchange
rate is estimated to be overvalued by between 6 and 12 percent and ten other G-20 economies are
in the same position: Australia, Brazil, Canada, France, Italy, Russia, Saudi Arabia, South
Africa, Turkey, and the United Kingdom. This section simulates two scenarios. The first
explores the implications of a new policy from the U.S. administration to push its real effective
exchange rate back down to what its fundamentals suggest it should be. The second explores the
implications of having the same policy adopted by the other G-20 economies that have
overvalued exchange rates. A forced depreciation of the U.S. real effective exchange rate
Achieving a depreciated U.S. real effective exchange rate is not straightforward. As discussed
earlier, the U.S. Treasury’s Exchange Rate Stabilization Fund is less than $100 billion, with
dollar holdings of just $23 billion. Selling dollars from this fund is unlikely to be enough to
Global implications of a US-led currency war Brookings Institution achieve a sustained
reduction in the U.S. dollar. “These dollar holdings might be sufficient to send a few warning
shots, but they are not enough for a major campaign,” warned Mark Sobel, a former Treasury
official under Barack Obama, adding that the massive scale of the euro/dollar market and
China’s ability to exert control over the renminbi would likely stymie any U.S. move
(Sevastopulo et al., 2019). Another option, assumed to be the case in the simulations below, is
for the U.S. Federal Reserve to take the lead. This policy involves the Fed abiding by the wishes
of President Trump, Elizabeth Warren, and those who sponsored the bipartisan bill in the U.S.
Senate discussed earlier, by agreeing to maintain low interest rates while tolerating higher
inflation to achieve a sustained reduction in the value of the U.S. dollar. Achieving this may be
more difficult at present given the relatively non-responsive Phillips Curve in the United States.
But it is reasonably assumed that, with enough effort, the Fed is ultimately able to achieve this
outcome. Given the U.S. dollar is assessed by the IMF to be between 6 and 12 percent
overvalued, the below simulation assumes the U.S. seeks to depreciate the exchange rate by the
midpoint of this estimate: 9 percent. Consider first the implications of this policy for the United
States. U.S. authorities bring about the depreciation in the dollar by pushing down interest rates.
Short-term interest rates fall by 250 basis points (2.5 percent) in the first year and inflation is
permanently higher. As of 13 August 2019, the U.S. Federal Funds Rate is at 2.25 percent. The
G-Cubed model therefore assumes that the U.S. Federal Reserve is able to stimulate the economy
through negative short-term interest rates. By way of context, a five percent cut in interest rates
is how much the U.S. Federal Reserve normally reduces interest rates during an economic
downturn. The consequence of this policy is that financial capital shifts out of the U.S. to enjoy
higher interest rates overseas. As capital leaves the U.S., it pushes down the exchange rate. This
brings about the desired depreciation of the nominal exchange rate which falls 9 percent
(reflected in the model as a nominal appreciation in the exchange rates of U.S. trading partners).
The effect on the real effective exchange rate is more muted, falling by 3.5 percent. This
depreciation in the real effective exchange rate is only temporary. The 3.5 percent depreciation
only lasts for the first year of the shock. In the second year, the real effective exchange rate is
only 1 percent below the baseline and then gradually returns to baseline over the following five
years. The reason for this is straightforward. Recall that the real effective exchange rate is the
nominal exchange rate multiplied by the ratio of prices in the United States and the prices
prevailing overseas (weighted by how much those countries trade with the United States). Even
though the nominal exchange rate is depreciating (acting to reduce the real effective exchange
rate), U.S. prices are also increasing due to permanently higher inflation (acting to increase the
real effective exchange rate). Prices also adjust in the economies of U.S. trading partners which,
in many instances, further offset the nominal exchange rate depreciation. The fact that prices will
eventually adjust reveals the first of three critical insights for the United States in deciding
whether it should pursue this policy: that the effect of this policy in depreciating the real
effective exchange rate is only temporary. Lower interest rates also have substantial
consequences for investment and consumption in the U.S. but, like the exchange rate, these
effects are only temporary. U.S. investment spikes by 20 percent relative to the baseline in the
first year as firms’ borrowing costs fall and as they respond to higher domestic prices (brought
about by the increase in inflation) and higher short- Global implications of a US-led currency
war
And Other Outlooks

Are We in a Currency War Now?

In the current era of floating exchange rates, currency values are determined primarily by market
forces. However, currency depreciation can be engineered by a nation's central bank through
economic policies that have the effect of reducing the currency's value.

Reducing interest rates is one tactic. Another is quantitative easing (QE), in which a central bank
buys large quantities of bonds or other assets in the markets.

These actions are not as overt as currency devaluation but the effects may be the same.

The combination of private and public strategies introduces more complexities than the currency
wars of decades ago when fixed exchange rates were prevalent and a nation could devalue its
currency by the simple act of lowering the "peg" to which its currency was fixed.

Currency War or 'Competitive Devaluation'?

"Currency war" is not a term that is loosely bandied about in the genteel world of economics and
central banking, which is why former Brazilian Finance Minister Guido Mantega stirred up a
hornet's nest in September 2010 when he warned that an international currency war had broken
out.1

In more recent times, nations that adopt a strategy of currency devaluation have underplayed
their activities, referring to it more mildly as "competitive devaluation."

A currency war is sometimes referred to by the less-threatening term "competitive devaluation."

In 2019, the central banks of the U.S., the Bank of England, and the European Union were
engaged in a "covert currency war," according to a report in CNBC. With interest rates at rock
bottom, currency devaluation was one of the only weapons the central banks had left to stimulate
their economies.2

In the same year, after the Trump administration imposed tariffs on Chinese goods, China
retaliated with tariffs of its own as well as devaluing its currency against its dollar peg. That
could have escalated a trade war into a currency war.3

Why Depreciate a Currency?

It may seem counter-intuitive, but a strong currency is not necessarily in a nation's best interests.

A weak domestic currency makes a nation's exports more competitive in global markets while
simultaneously making imports more expensive. Higher export volumes spur economic growth,
while pricey imports have a similar effect because consumers opt for local alternatives to
imported products.
This improvement in the terms of trade generally translates into a lower current account
deficit (or a greater current account surplus), higher employment, and faster growth in gross
domestic product (GDP).

The stimulative monetary policies that usually result in a weak currency also have a positive
impact on the nation's capital and housing markets, which in turn boosts domestic consumption
through the wealth effect.

Beggar Thy Neighbor

Since it is not too difficult to pursue growth through currency depreciation—whether overt or
covert—it should come as no surprise that if nation A devalues its currency, nation B will soon
follow suit, followed by nation C, and so on. This is the essence of competitive devaluation.

The phenomenon is also known as "beggar thy neighbor," which is not a Shakespearean turn of
phrase but a national monetary policy of competitive devaluation pursued to the detriment of
other nations.

The U.S. Dollar's Surge

When Brazilian minister Mantega warned back in September 2010 about a currency war, he was
referring to the growing turmoil in foreign exchange markets, sparked by new strategies adopted
by several nations. The U.S. Federal Reserve's quantitative easing program was weakening the
dollar, China was continuing to suppress the value of the yuan, and a number of Asian central
banks had intervened to prevent their currencies from appreciating.

Ironically, the U.S. dollar continued to appreciate against almost all major currencies from then
until early 2020, with the trade-weighted dollar Index trading at its highest levels in more than a
decade.

Then, in early 2020, the coronavirus pandemic struck. The U.S. dollar fell from its heady heights
and remained lower. That was just one side effect of the coronavirus pandemic and the Fed's
actions to increase the money supply in response to it.4

The U.S. Strong Dollar Policy

The U.S. has generally pursued a "strong dollar" policy for many years with varying degrees of
success. The U.S. economy withstood the effects of a stronger dollar without too many problems,
although one notable issue is the damage that a strong dollar causes to the earnings of American
expatriate workers.

However, the U.S. situation is unique. It is the world's largest economy and the U.S. dollar is the
global reserve currency. The strong dollar increases the attractiveness of the U.S. as a destination
for foreign direct investment (FDI) and foreign portfolio investment (FPI).
Not surprisingly, the U.S. is a premier destination in both categories. The U.S. is also less reliant
on exports than most other nations for economic growth because of its giant consumer market,
by far the biggest in the world.

The Pre-COVID-19 Situation

The dollar surged in the years before the COVID-19 pandemic primarily because the U.S. was
the first major nation to unwind its monetary stimulus program, after being the first one out of
the gate to introduce QE.

The long lead-time enabled the U.S. economy to respond positively to the Federal Reserve's
successive rounds of QE programs.

Other global powerhouses like Japan and the European Union were relatively late to the QE
party. Canada, Australia, and India, which had raised interest rates soon after the end of the Great
Recession of 2007-09, had to subsequently ease its monetary policy because growth momentum
slowed.

Policy Divergence

While the U.S. implemented its strong dollar policy, the rest of the world largely pursued easier
monetary policies. This divergence in monetary policy is the major reason why the dollar
continued to appreciate across the board.

The situation was exacerbated by a number of factors:

 Economic growth in most regions was below historical norms; many experts attributed
this sub-par growth to fallout from the Great Recession.
 Most nations exhausted all other options to stimulate growth, with interest rates at
historic lows. With no further rate cuts possible and fiscal stimulus not a controversial
option, currency depreciation was the only tool remaining to boost economic growth.
 Sovereign bond yields for short-term to medium-term maturities had turned negative
for a number of nations. In this extremely low-yield environment, U.S. Treasuries
attracted a great deal of interest, leading to more dollar demand.

Negative Effects of a Currency War

Currency depreciation is not a panacea for all economic problems. Brazil is a case in point. The
country's attempts to stave off its economic problems by devaluing the Brazilian real created
hyperinflation and destroyed the nation's domestic economy.

So what are the negative effects of a currency war? Currency devaluation may lower productivity
in the long term since imports of capital equipment and machinery become too expensive for
local businesses. If currency depreciation is not accompanied by genuine structural reforms,
productivity will eventually suffer.
Among the hazards:

 The degree of currency depreciation may be greater than what is desired, which may
cause rising inflation and capital outflows.
 Devaluation may lead to demands for greater protectionism and the erection of trade
barriers, which would impede global trade.
 Devaluation can increase the currency's volatility in the markets, which in turn leads to
higher hedging costs for companies and even a decline in foreign investment.

The Bottom Line

It does not appear that the world is currently in the grips of a currency war. Recent rounds
of easy money policies by numerous countries represent efforts to combat the challenges of a
low-growth, deflationary environment, rather than an attempt to steal a march on the competition
through overt or surreptitious currency depreciation.

What Harm Can a Currency War Do?

A currency devaluation, deliberate or not, can damage a nation's economy by causing inflation. If
its imports rise in price. If it cannot replace those imports with locally-sourced products, the
country's consumers simply get stuck with the bill for higher-priced products.

A currency devaluation becomes a currency war when other countries respond with their own
devaluations, or with protectionist policies that have a similar effect on prices. By forcing up
prices on imports, each participating country may be worsening their trade imbalances instead of
improving them.

Does Chinese Currency Affect Trade Wars?

It may be the reverse: a trade war damages the currency of the country it targets.

The United States has an enormous trade gap with China. That is, the U.S. imports more than
$375 billion worth of goods from China than it imports from the U.S., as of 2019.

In 2020, then-President Donald Trump tried to correct that imbalance by imposing a raft of
tariffs on Chinese goods entering the U.S. This protectionist policy was aimed at increasing the
prices of Chinese goods and therefore making them less attractive to U.S. buyers.

One effect was an apparent shift in U.S. manufacturing orders from China to other Asian nations
such as Vietnam. Another effect was a weakening of the Chinese currency, the renminbi. Less
demand for Chinese products led to less demand for the Chinese currency.5
What Do Countries Try to Achieve in a Currency War?

A country devalues its currency in order to decrease its trade deficit. The goods it exports
become cheaper, so sales rise. The goods it imports become more expensive, so their sales
decline in favor of domestic products. The end result is a better trade balance.

The problem is, other nations may respond by devaluing their own currencies or imposing tariffs
and other barriers to trade. The advantage is lost.

Is India in a Currency War?

The U.S. Treasury Department placed India on its watchlist of currency manipulators in April
2021. It cited India's outsized purchase of U.S. dollars as a possible attempt at currency
manipulation.6

India's rupee hit a record low of 1 U.S. dollar to 76.67 Indian rupees in March 2020, at the start
of the global economic crisis caused by the COVID-19 pandemic.7

The rupee has had a tumultuous history since its introduction in 1947 when the nation achieved
its independence. The nation moved from a dollar peg to a floating currency in 1991 and, at the
same time, devalued the currency to about 1 U.S. dollar to 26 rupees.

The rupee's value remained relatively high through the first years of its remarkable economic
growth but faltered during the economic crisis of 2008-2009.8

As of Feb. 5, 2022, it remained relatively low at 1 U.S. dollar to 74.64 rupees.

Currency Manipulation

Currency manipulator is a designation applied by United States government authorities, such

as the United States Department of the Treasury, to countries that engage in what is called
“unfair currency practices” that give them a trade advantage. Such practices may be currency
intervention or monetary policy in which a central bank buys or sells foreign currency in
exchange for domestic currency, generally with the intention of influencing the exchange
rate and commercial policy. Policymakers may have different reasons for currency intervention,
such as controlling inflation, maintaining international competitiveness, or financial stability. In
many cases, the central bank weakens its own currency to subsidize exports and raise the price
of imports, sometimes by as much as 30-40%, and it is thereby a method
of protectionism. Currency manipulation is not necessarily easy to identify and some people have
considered quantitative easing to be a form of currency manipulation.

Under the 1988 Omnibus Foreign Trade and Competitiveness Act, the United States Secretary of
the Treasury is required to "analyze on an annual basis the exchange rate policies of foreign
countries … and consider whether countries manipulate the exchange rate between their currency
and the United States dollar for purposes of preventing effective balance of
payments adjustments or gaining unfair competitive advantage in international trade" and that "If
the Secretary considers that such manipulation is occurring with respect to countries that (1) have
material global current account surpluses; and (2) have significant bilateral trade surpluses with
the United States, the Secretary of the Treasury shall take action to initiate negotiations with such
foreign countries on an expedited basis, in the International Monetary Fund or bilaterally, for the
purpose of ensuring that such countries regularly and promptly adjust the rate of
exchange between their currencies and the United States dollar to permit effective balance of
payments".
Case Study

CASE 1: UK leaving ERM

The Exchange Rate Mechanism (ERM) created in 1979 laid the foundation for the later
Economic and Monetary Union (EMU). The UK joined the ERM in 1990 (and left in 1992) but
obtained an opt-out from joining EMU in return for agreeing to the next major Treaty
amendment, the Maastricht Treaty, in 1991. The Maastricht Treaty (the Treaty on European
Union) also created the three-pillared structure which included intergovernmental decision-
making in foreign and security policy and justice and home affairs matters.

This Treaty was controversial in the UK Parliament, because the Conservative Government
under John Major had opted out its social policy provisions. In 1993 a confidence motion
narrowly ensured parliamentary support for the Government's EC policy and the Treaty was
subsequently ratified. The next Treaty amendment agreed in Amsterdam in 1997 included
adoption of EU social policy provisions by the Labour Government of Tony Blair.

On 1 January 1999 the single currency, the Euro, was adopted as the official currency of 11 of
the 15 EU Member States. EMU was completed in 2002 when Euro coins and notes entered
circulation for Eurozone States.

Maastricht Treaty

The Maastricht Treaty (full name: the Treaty on European Union) 1991 was a major amendment
of the 1957 Treaty of Rome and highlighted the divide between Member States that wanted more
integration (e.g. Germany) and those that wanted to co-operate on a voluntary and
intergovernmental basis (e.g. Britain). The Treaty also established a timeline for Economic and
Monetary Union (EMU) and set out the economic “convergence criteria” States needed to
achieve and maintain, in order to adopt the single currency. The UK secured an opt-out from
EMU.

The Maastricht Treaty also officially changed the name of the EEC to the European Union (EU).

After a flood of selling the pound on foreign stock exchanges, Britain was forced to leave the
ERM in 1992,  less than two years after joining. This day became known as ‘Black Wednesday',
costing the UK Treasury £3.3 billion.

Single Market established

The Single Market was established in 1993, paving the way for the free movement of goods,
capital, services and people.

In December the EU concluded the Agreement on the European Economic Area (EEA

Agreement) with Austria, Finland, Iceland, Liechtenstein, Norway, Sweden and Switzerland. All
but Switzerland later ratified the EEA Agreement, which opened up the internal market to EEA
members.
The Channel Tunnel was opened in 1994, linking Britain to mainland Europe.

In January 1998 the UK took over the EU Presidency for six months. The European Council was
held in June in Cardiff.

Treaty of Amsterdam

In 1997 the Treaty of Amsterdam was agreed. This Treaty incorporated the Schengen provisions
on the abolition of internal border controls and a common visa policy into the EU Treaties, with
opt-outs for the UK and Ireland.

Introduction of EU single currency

On 1 January 1999 the single currency, the Euro, was adopted as the official currency of 11 of
the 15 EU Member States, but as a ‘virtual currency' for commercial and financial transactions
only.

At the Helsinki European Council in December 1999, the EU agreed to open accession
negotiations with several East European states, Cyprus and Malta, and recognised Turkey as an
applicant state.

Twelve European states adopted the Euro as legal tender on 1 January 2002, and began to phase
out their national currencies. Britain, Sweden and Denmark did not join the single currency.
Conclusion

“Other countries around the world doing anything possible to take advantage of the United
States, knowing that our Federal Reserve doesn’t have a clue!” tweeted the President of the
United States. “They raised rates too soon, too often, & tightened, while others did just the
opposite.... Our most difficult problem is not our competitors, it is the Federal Reserve!” This
paper explored what would happen if President Trump and others, such as Presidential hopeful
Elizabeth Warren, were delivered this wish. It explored what would happen if the U.S. Federal
Reserve aggressively cut interest rates and tolerated higher inflation in order to bring down the
U.S. real effective exchange rate which, according to analysis from the IMF, is overvalued by
between 6 and 12 percent. The paper then explored what would happen if other countries
retaliated given that 11 of the G-20 economies are in the same position as the United States in
having overvalued exchange rates—including Australia, Brazil, Canada, France, Italy, Russia,
Saudi Arabia, South Africa, Turkey and the United Kingdom—along with many more outside
the G-20 grouping. The analysis reveals several insights, and warnings, for the U.S.
administration. First, it shows that many of the allegations from the U.S. administration about the
currencies of other economies are not substantiated. China, for example, historically had an
exchange rate that was undervalued by between 5 and 10 percent but has been assessed as being
broadly in-line with its fundamentals over the last five years.

Since 2012, most G-20 countries are in the same position as the United States in having
consistently overvalued exchange rates, including Australia, Brazil, Canada, France, Italy,
Russia, Saudi Arabia, South Africa, Turkey, and the United Kingdom. Others have consistently
undervalued exchange rates—the euro area, Germany, Japan, Korea, and Mexico—but there is
no evidence of persistent one-sided interventions in foreign exchange markets, according to U.S.
Treasury assessments. Second, a policy of lowering interest rates to devalue the U.S. real
effective exchange rate is only temporarily effective. Even though the policy brings about a
sustained depreciation in the nominal exchange rate (acting to reduce the real effective exchange
rate), it also causes U.S. prices to rise due to permanently higher inflation (acting to increase the
real effective exchange rate). As a result, the desired depreciation in the real effective exchange
rate only lasts for the first year of the shock. In the second year, the real effective exchange rate
is only 1 percent below the baseline and then gradually returns to baseline over the following
five years. Third, the economic benefits of this policy are also temporary. Consumption and
investment rise sharply as firms and households respond to lower interest rates and GDP
improves. But the economy quickly adjusts. As a result, most of the benefits that flow from this
shock have evaporated within the space of two or three years. This also assumes there is no
increase in risk premia which, as investors became concerned by unpredictable exchange rate
and monetary policy frameworks, would have a variety of negative consequences. Fourth, even
though the real effective exchange rate is depreciated by this policy (albeit only temporarily), the
U.S. trade deficit is worsened, not improved. Rather than improving the U.S. trade balance, the
model finds that the U.S. trade balance weakens by 0.4 percent of GDP in the first year and 0.1
percent of GDP in the second year.

The reason for the worsened trade balance is that there are a variety of forces other than the real
effective exchange rate which impact upon the trade balance, particularly consumption and
investment. As consumers increase their consumption, they increase their consumption of both
domestic and imported goods, particularly favoring imported goods given relative price effects
through the increased price of domestically produced goods from higher inflation. Similarly for
investment, some of the savings needed to finance the large increase in U.S. investment comes
from overseas which acts to moderate the capital outflows triggered by lower U.S. interest rates.
If reducing the U.S. trade deficit is a goal of the Trump administration, this paper suggests that
sustained cuts to U.S. interest rates will have the opposite effect. Fifth, the paper shows that this
policy results in China’s real effective exchange rate becoming undervalued, the opposite of the
Trump administration’s stated objective for the Chinese currency. The paper also shows that the
policy improves the trade balances of most U.S. trading partners and boosts Chinese GDP. If the
objective of a depreciated U.S. real effective exchange rate was to claw back demand from other
countries, these results, again, show that such as policy has the opposite effect. The paper finds
that seven G-20 economies see their already overvalued exchange rates made even more
overvalued by this U.S. policy. This means that, for many economies, the policy from the U.S.
worsens global currency misalignments rather than improves them. The paper therefore explores
what would happen if these countries undertook the same policy as the US. Another insight from
the simulations is that having countries retaliate makes it harder for the U.S. to achieve its
objective of a depreciated real effective exchange rate. While the U.S. is depreciating its nominal
exchange rate against other countries, other countries now push it back up. The net effect for the
United States is that it is unable to depreciate its exchange rate by the same amount.

The same is true for the other economies seeking to do the same thing. Any of these countries
could achieve their objective if they were acting alone, albeit temporarily. But when other
countries are trying to do the same thing, the story is much more complex. The critical impact of
having other countries with overvalued exchange rates implement this policy along with the U.S.
is that it forces more adjustment onto the countries that have undervalued exchange rates which
are not implementing this policy. This means that countries like Germany have more substantial
exchange rate adjustments forced upon them than when the U.S. is acting alone. The
implications of having many countries acting at the same time causes even more turbulence for
capital and trade flows, exacerbating the investment and consumption effects from when the U.S.
acts alone. In sum, this paper is a warning that the general equilibrium effects of a depreciated
real effective exchange rate, and the mechanisms utilized to achieve that depreciation, can result
is a wide variety of unintended consequences. If the objective of the U.S. administration is to
worsen their trade deficit, only temporary devalue the U.S. real effective exchange rate, boost the
trade balances of U.S. trading partners, support China’s economy and undervalue China’s real
effective exchange rate, provide only a temporary sugar-hit to the U.S. economy, worsen global
currency misalignments and provoke retaliation from their trading partners, then this policy will
achieve those objectives.

If these are not the objectives of the U.S. administration, then it would be wise to seek
alternatives. One alternative policy would be a reversal of the substantial U.S. fiscal stimulus
which would lower the U.S. government demand for global savings to finance rising U.S. fiscal
deficits. Dealing with the unsustainable expansion of U.S. fiscal deficits would lead to a
deprecation of the real effective exchange rate and a more sustained improvement in the U.S.
trade balance.
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