The currency war

Raffaele Zenti Fx Leave a Comment

We started talking about the “currency war” following the decision of the Japanese Prime Minister Abe to change tactics to stimulate the economy with an aggressive central bank policy.

The strategy of the central bank consists of introducing liquidity into the system, a great deal of cash. The cash introduced has had an impact on the depreciation of the yen against major currencies. This, in turn, makes the Yen less expensive and thus makes Japanese products more competitive in foreign markets, which is beneficial for economic growth in Japan.

And therein lies the problem: with the global economic recovery struggling (in Italy, growth is very weak), Japan’s attempt to solve the problem of deflation, depreciating the yen, has generated the fear that we may be faced with a new war of currencies, such as the one that happened in the ‘30s of last century.

The scheme of a currency war, in the simplified case of only two countries, is as follows: if the currency of country A depreciates in relation to that of country B, the export of country B to country A is harmed because its goods and services have suddenly become more expensive, while  country A has an advantage and is able to sell more products. Then also country B will do anything to devalue its currency. And so on, over and over.

As I think you have guessed, since the changes in prices are by nature dependent on each other, it is impossible for all currencies to depreciate simultaneously ….. depreciation is a zero-sum game. Hence economic war is totally meaningless. The only case in which a currency war may make sense is the depreciation of the currency of a “small country”, whose policy can be tolerated by the “big countries “. But this is not the case we face today. Here, major blocs are confronting each other: Japan, the USA, Europe and the UK as well as the main Emerging Countries.

What are the consequences ?

A war between large currency areas would only cause the resurgence of protectionist measures: each of these areas will seek to raise economic barriers.  Protectionist measures may be a temporary buffer, but ultimately they seriously damage international trade. Among the main consequences would be the severe impact on employment, with the loss of many jobs (as happened during the “Great Recession” of the ’30s, when the UK began a series of devaluations) .

 

 

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About the Author

Raffaele Zenti

Co-founder and Head of the Financial Strategies Group of Adviseonly (www.adviseonly.com). Expert in finance and risk management. He graduated in Economics from the University of Turin, with a specialisation in Statistics. He has worked in assets allocation for Sella Asset Management, where he was head of the Financial Business Consultants unit in Engineering. Previously he worked at Allianz Global Investors Italy for ten years as Head of Risk Management and then as Head of Quantitative Management. He was recently the Quantitative Management Manager at Banca Leonardo Group and provided independent consultancy for IDeA Sim - DeA Group. He is also a lecturer in Quantitative Portfolio Management at the University of Turin Master’s in Finance programme, has published various articles in asset management and finance magazines (including the Journal of Asset Management, Economic Notes and Risk) and has contributed to books on subjects related to investment choices and Risk Management.

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