Are we in a currency war?
Since the beginning of 2015, more than 20 central banks around the world have cut benchmark interest rates (loose monetary policy), led by the European Central Bank (ECB) and the Bank of Japan (BOJ). With so many banks taking action, in February 2015, Bank of America ML estimated currency volatility to be at a 20-year high.1
The map above shows the cuts by various banks around the world2 (for map details, scroll to the end of this post). The fall of global currencies has been driven primarily by monetary policies of foreign banks. Meanwhile, the U.S. dollar has climbed the currency charts in the last 12 months as other currencies around the world have fallen. This raises the question:
Are we in a currency war – should investors be worried or is this another media-fueled apocalypse du jour?
What is a currency war?
The term stems from the perception that currency devaluation is a zero-sum game that represents an economic battle where some countries use different policies such as lowering interest rates to improve their growth, causing other countries with stronger currencies and higher rates to suffer a slowdown in growth. Lower rates cheapen a country’s domestic currency, improving exports, international trade, staffing deflation, employment and economic growth. For example, a cheaper U.S. currency could make Boeing more competitive internationally with France’s Airbus. The problem is that when one country starts to weaken its currency, other countries follow suit, and that could spiral a race to the bottom. If multiple countries try to compete by devaluing their currencies for too long, that could result in protectionism and insulated trade barriers by countries. Such moves may limit the benefits of free trade and reduce global growth.
Are currency wars common?
While currency wars are not a daily phenomenon, we have seen a few of them in history. During the Great Depression, many countries devalued their currencies to help their countries grow out of Depression, arguably making the Depression worse. In 1931 alone, 17 countries abandoned the Gold Standard and/or devalued their currencies.3
More recently, in 2010-11, China and U.S. exchanged heated words over the valuation of China’s yuan. In 2013, Japan’s quantitative easing program sparked concerns about currency war breaking out.4 In January 2015, fears of another currency war were ignited once again as the European Central Bank launched its quantitative program and 20 Central Banks around the world lowered their rates.
Can a currency war be good?
Some contend that currency devaluation could result in a positive-sum game as devalued currencies may boost domestic demand in countries and thereby help global demand and make everybody better off. Lower rates help consumers spend more in their own country which is good for global demand as consumers buy products which are produced both domestically and globally.
The media use the term “currency war” to boost ratings, as fear generates more readers. The kernel of truth lies not in the words used to describe the action, but in its potential impact on the economy. Historically, devalued currencies have helped increase global growth, employment, global trading and stocks. Devaluing currencies historically has helped in deflationary times by boosting domestic demand and staving off deflation (a bigger economic risk than devaluation).5 However, devaluation could hurt in hyper inflationary times like we had in the 1970s.
Stop Worrying about ‘Currency Wars Bloomberg author Ramesh Ponnuru discusses the benefits of currency devaluation. He references the work done by Scott Summer, an economics professor at Bentley University, who noted that in recent times, monetary easing by a country has tended to boost stocks of other countries. The article also discusses the findings of the International Monetary Fund in 2011, which determined that the “spillover effects” of the U.S.’s Quantitative Easing or low rates program had a positive impact on other countries. Another positive impact of lowering rates is that investors typically invest in countries where rates are higher, thereby raising that country’s asset prices.
Barry Eichengreen, a professor at University of California, has written extensively on the positive impacts of currency devaluation, arguing that “What are now referred to as currency wars were part of the solution, not part of the problem.”6
These views are quite contrary to the generally accepted view that currency devaluation often creates a crisis. Currency is like a commodity whose value over the long term is determined by its supply and demand. In the short term, a strong dollar might hurt U.S. growth and the weaker global currencies might strengthen global growth; but in the long term, their intrinsic value will be determined by their supply and demand.
Conclusion: We do not believe we are experiencing a “currency war.” This is just another apocalypse du jour. Moreover, we believe “war” actually could be good for business! We have been in a period of low rates for a while and deflation has been a threat. We believe various central banks are now trying to fight off deflation with the few remaining tools they have, including quantitative easing. And regardless of what actions central bankers might take, in the end, it is the fundamentals of companies, consumers and the economy that keep companies growing and reward long-term investors. Though currency volatility might indeed be up, we maintain that does not alter these fundamental tenets of investing. This time is not different.
Thank you JOYN. Article previously posted here:
https://joynadvisors.com/should-investors-worry-currency-wars/
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