Competitive Devaluation in Play?

Currency war or competitive devaluation refers to a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency.

As what had happened recently, most currencies have depreciated against the US Dollar through measurements such as Quantitative Easing, or lowering of interest rate. Euro, AUD, Japanese Yen, and New Zealand Dollar are among the currencies that had depreciated against USD quite substantially.

Shown below are the exchange rate of these currencies against USD between 1/11/14 and 31/1/15:

Currency Nov 1, 2014 Jan 31, 2015 Changes
EURO 1.2525 1.1285 -9.9%
NZD 0.7793 0.7250 -6.97%
AUD 0.8799 0.7770 -13.3%
SGD 0.7779 0.7384 -5.1%
JPY 0.00886 0.00851 -3.95%

So, why there was attempt to bring their currencies down? A general theory is that exchange rate has an effect on the trade surplus (or deficit). A weaker domestic currency stimulates exports and makes imports more expensive. Conversely, a strong domestic currency hampers exports and makes imports cheaper. A trade surplus occurs if a country’s exports exceeds its imports. A trade surplus represents a net inflow of domestic currency from foreign markets, and is the opposite of a trade deficit, which would represent a net outflow.

Countries occasionally try to resolve their economic problems by resorting to methods that artificially depress their currencies in an effort to gain an advantage in international trade. One such technique is “competitive devaluation,” which refers to the strategic and large-scale depreciation of a domestic currency to boost export volumes. In this case, the country whose currency is devaluated could benefit form the lower cost of its export of goods, which now are cheaper to buy by customers in countries whose currencies are stronger.

So, the question would be, why are countries jump into currency war? It is most probably coming from one motivation – to stimulate growth. The cycle to currency devaluation goes something like this. With consumers looking to pay down debt or unwilling to spend, there is weak demand. In the face of weak demand, there’s less investment. Governments can only spend so much in their vain attempts to prop up a struggling economy. That leaves one area of potential growth possible – exports. The fastest way to boost exports is to make them cheaper.

As all economies are inter-related. Currency war could never go on forever as it will create no winner at the end. Currency devaluation may sound positive on the export and trade surplus but it dampen consumer sentiment in spending especially the imported goods are becoming so expensive. Also, people will spend less in holiday as currency depreciated.  As every economies are part of the eco-system, no one is going to be the sole beneficiary if everyone are jumping into currency war.



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