He who tampers with the currency robs labor of its bread. — Daniel Webster
With a nod to China’s impressive growth over the past 25 years, the United States remains the world’s preeminent economic superpower, both in sheer size as well as overall global impact. In a manner of speaking, when the U.S. ‘talks’ — the world listens.
That’s why after observing the steps the U.S. and other countries were taking in the wake of the Great Recession, Brazil’s finance minister Guido Mantega coined the term ‘currency war’ in the following 2010 quote:
‘We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.’
Mantega’s comments were in reference to actions beyond the natural ebbs and flows of international trade. More specifically, that currency manipulation was occurring worldwide, and how he perceived it as a threat to the global economy. What was Mantega referring to, and is such a phenomenon occurring today around the world?
What Is Currency Manipulation?
Currency manipulation occurs when a country takes steps to purposely weaken its currency against other world currencies. By doing so, that country can sell its products cheaper on the world market due to lower exchange rates. Conversely, imports become more expensive. The net result is decreased imports, increased exports and an improved domestic economy — at the expense of economic hits taken by other countries.
Historically, the most common method by which to manipulate currency values has been as follows:
- Selling of one’s own currency into the foreign exchange markets and/or purchasing another country’s currency, driving down the value of the sold currency and increasing the relative value of the purchased currency.
Many consider this practice as damaging to world trade because it circumvents natural supply/demand factors, inflicting economic harm to affected countries. The negative impacts of such manipulation include reduced GDP, job losses from lower exports, and potential deflation due to downward pressure on interest rates.
Quantitative Easing and Currency Manipulation
In recent years — particularly in the wake of three rounds of quantitative easing by the United States — economists have begun labeling the practice as yet another form of currency manipulation.
Quantitative easing in the U.S. directly lowered both short and long-term interest rates, prompting yield-hungry dollars to leave the U.S. in favor of other markets. As dollars flooded into foreign countries, the respective currencies strengthened in relationship to the dollar due to the laws of supply and demand.
What Goes Around, Comes Around
In the four years between 2008 and 2012 as the US deployed QE1, QE2, Operation Twist and QE3 in full measure, the U.S. dollar fell against most major currencies. The dollar lost nearly 20% of its value against the Japanese yen, 10% versus the Chinese yuan, 20% against the Canadian dollar, 35% against the Australian dollar and 20% versus the Mexican peso. No doubt due in large part to Europe’s double-dip recession, the value against the Euro remained unchanged.
As quantitative easing wound down in the U.S. starting in 2013, the dollar rebounded. Over the past two years, the dollar has rocketed upward, increasing 20% or more against virtually all major world currencies. The European Central Bank’s recent announcement of a massive upcoming round of quantitative easing (deemed necessary due to Europe’s moribund economies) is sure to send the dollar spiraling higher still. The likely impact on the U.S. economy will be an increase in the trade deficit and a drag on economic growth.
What Are the Numbers Involved?
According to the Economic Policy Institute, the benefits of eliminating currency manipulation would include the following:
- Reducing the U.S. trade deficit by $200 – 500 billion in three years.
- Increasing annual U.S. GDP by between $288 billion and $720 billion (between 2.0 percent and 4.9 percent).
- Creating 2.3 million to 5.8 million jobs.
- Adding between 891,500 and 2,337,300 to manufacturing payrolls.
- Reducing federal budget deficits by between $107 billion and $266 billion in 2015 alone.
What Can Be Done About Currency Manipulation?
On February 10, 2015, H.R. 820 (“Currency Reform for Fair Trade Act”) was assigned to a congressional committee. If passed by both houses of Congress and signed into law by the president, the bill would impose tariffs on currency manipulators. Secondly, proposed Trans-Pacific Partnership (TPP) trade agreements could include appropriate language designed to thwart manipulation. Lastly, taxes and other punitive measures could be levied on asset purchases within the United States by offending countries.
Currency Wars To Come?
The likelihood of decisive action by the United States in the near future is low. However, as can be seen in the above statistics, the cost of currency manipulation is unacceptably high and bound to go up in coming years as currency wars continue across the global economy.
As former Fed Chairman Ben Bernanke once said, “Monetary policy is not a panacea.” Over the past two years, the U.S. has seen the truth in that statement first hand.
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