The International Currency War

The Brazilian finance minister, Guido Mantega, finally admitted there’s a war out there. He called it by its name: an international currency war. The Brazilean real has surged 35% against the US dollar since the beginning of the year. Mantega vows to put a stop to this climb.

What is the problem?

currency warsLet’s take a look at the relationship between the USD and the CAD. If the Canadian dollar rises relative to the US dollar, all the goods and services imported by Canada become cheaper because Canadian importers need to buy less US dollars in order to make their payment.

On the other hand, the goods & services that Canada exports become more expensive because US importers need more US dollars to buy the same amount of Canadian dollars in order to make their payment.

If the country relies on exports as the engine of its economic growth, any appreciation of its currency against other currencies is a major problem as it makes exporting harder. The goods & services exported become more expensive relative to the same goods & services offered by a competing country, which could lead to job losses among exporting companies.

How do you avoid such a scenario? The central bank usually intervenes to control any currency appreciation or depreciation that is deemed harmful to the national economy. In our example, the Bank of Canada would sell billions of Canadian dollars buying US dollars in return in order to stop and reverse any appreciation in the CAD.

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Central banks around the world have been intervening to make their currencies cheaper in an effort to protect their exports. This month the bank of Japan intervened in the currency markets by selling its Yen currency against the US dollar in order to protect its exporters. The Yen reached a 15-year high against the dollar, a level Japanese financial authorities cannot ignore.

China continues to suppress the value of the Yuan relative to the US dollar. It is considered an unfair advantage for their exports since they will always appear cheaper compared to those of other countries. Usually, the value of a currency relative to another is determined in the foreign exchange markets based on supply and demand. However, China pegs their currency to the US dollar maintaining it at a constant value which explains why the USA has been increasing political pressure on China in order to let the Yuan appreciate.

A depreciating currency is a great way to boost one’s competitiveness but when done on a wide scale by several players, it usually inflames international tensions as each country is seeking to protect its own economic interest.

South Korean authorities intervened early this week by buying US dollars in order to curb the Won’s rise to 4 months high. This is not going to be the last intervention as others besides Brazil have warned about risks to their currency. Remember that the one with the most exports wins with tax revenues and jobs.

The International Monetary Fund Managing Director Mr. Strauss-Kahn sees no risk of a currency war. I wonder how mad the Brazilian finance minister must have been in order to shout it out loud. Until an international coordinated economic policy is put in place, expect more interventions and more complaining by central bank governors like Mr. Mantega. I believe the war is just in its beginning, wait until the USD hits a crisis point because of all of that debt!

Do you think precious metals will continue to shine while fiat currencies battle it out?