The Currency War – Now and Then

Global currency wars worries have resurfaced in recent weeks, mainly because of Japanese action on the yen.

In order to understand the meaning of this so-called war, we would have to go back in time to the 1930’s.

Back then, the currency wars scared economists as they had a big part in the Great Depression in the 1930’s.

The damage done to global financial markets in that period took several decades to repair, and a repeat of this nightmare cannot be ruled out completely.

However, there are large differences between the 1930’s and nowadays and the results of what is happening may differ as well. In the past, it seems like currency wars were defined as any policy that is intentionally designed to drive down the value of a currency, whether by local inflation or an exchange rate decline.

It is quite the same thing in the long run since a rise in inflation relative to other countries will eventually be fully reflected in a lower exchange rate.

The currency war - now and then

The currency war – now and then

So what about today’s currency wars?

The conclusion of what happened back then was that a currency war which results in an equal currency devaluation, along with monetary easing, would probably have been much less damaging than the direct trade and exchange control retaliations which actually occurred in the 1930’s.

Currency wars could still develop into direct trade wars, though even if they do not, they could lead to other problems like commodity inflation and asset price bubbles in the emerging economies, though so far, we are not seeing a repeat of the 1930’s.
Goldman Sachs bank support this opinion, stating that “this configuration of asset market moves – the real rate declines, steepening in nominal curves, currency depreciation and the pattern of domestic equity sector outperformance – is more consistent with a bout of monetary easing that is expected to prove expansionary, rather than a currency war interpretation”.
American economist Paul Krugman also believes that what is going on today is all a currency war misconception.

According to Krugman, it would be a very bad thing if policy makers take it seriously, as “the stuff that’s now being called “currency wars” is almost surely a net plus for the world economy.

In the 1930’s this was because countries threw off their golden fetters, they left the gold standard and this freed them to pursue expansionary monetary policies”.

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