The global reverse currency war has begun because in order to curb rising prices, major central banks are competing to increase the purchasing power of money and make the currency appreciate, but this hurts exporters. The crisis began with Isabel Schnabel, the ECB's executive board. In February, she criticized the euro for falling sharply against the dollar. Two months later, Bank of Canada Governor Tiff Macklem lamented the depreciation of the Canadian dollar. SNB Governor Thomas Jordan hinted he would like to see the Swiss franc strengthen.
The dollar has been soaring this year as the Fed has sharply raised interest rates to aggressively combat inflation — and has risen 7 percent this year. Other central bankers, equally desperate to curb rising inflation, began to send one hawkish signal after another that they welcomed the appreciation of the currency – which could help reduce import costs by boosting purchasing power overseas. Such interventions are so rare that they can influence the market with their shouts alone.
On June 16, two of these countries raised their bets: Switzerland raised interest rates for the first time since 2007, surprising traders and causing the Swiss franc to soar to its highest level in seven years. A few hours later, the Bank of England announced its own plans for a rate hike and hinted that it would raise rates more sharply.
The value of money accounts for an increasing proportion of inflationary factors. Goldman Sachs economist Michael Cahill said he hadn't yet expected central banks in developed countries to be so aggressive in getting their currencies to appreciate. The foreign exchange market calls it a "reverse currency war" – because for more than a decade, countries have sought to reduce the value of their currencies; Currency depreciation means that domestic companies can sell products overseas at more competitive prices, thus contributing to economic growth. But as the prices of everything from fuel, food to appliances soared, increasing international purchasing power suddenly became more important.
As we all know, currency wars are a zero-sum game. Alan Ruskin, chief international strategist at Deutsche Bank, said every country "wants the same thing" but "can't be like that in the world of forex."
Rare government exchange rate intervention
One of the most high-profile large-scale government interventions in the foreign exchange market occurred in 1985. During the first term of President Ronald Reagan, the dollar soared against the backdrop of rising long-term interest rates, with the dollar reaching its highest level ever against the pound.
The Reagan administration initially saw this as an affirmation of U.S. economic power, but the drawbacks soon became apparent. Reagan faced pressure from U.S. manufacturers who found it increasingly difficult to export their products overseas. Lee Morgan, then chief executive of machinery giant Caterpillar, estimated at the time that hundreds of U.S. companies lost billions of dollars a year to Japanese rivals in international orders due to a stronger dollar.
In September 1985, the Fed Chairman met with the governors of the central banks of France, Germany, Japan and the United Kingdom at the Plaza Hotel in New York. In the famous Plaza Accord, they proposed a plan to push the dollar down by 40% over the next two years; Until February 1987, the finance ministers of the seven countries and the governors of the central bank reached an agreement at the Louvre in Paris, signed the Louvre Agreement, and took joint measures to strengthen close coordination and cooperation in both domestic macro policies and foreign exchange market interventions to prevent the decline in the value of the US dollar at that time and maintain the basic stability of the US dollar exchange rate.
Since then, governments have rarely intervened so explicitly to influence the value of currencies, and more concise, ambiguous measures are more common. In 2010, Brazilian Finance Minister Guido Mantega accused countries such as Switzerland and Japan of deliberately depressing their local currencies to improve their competitiveness abroad. This tension has deepened the rift between emerging market and advanced economies.
Today, perhaps no country is better known than Japan for controlling the exchange rate of its local currency. The depreciation of the yen has allowed companies such as Toyota motor and Nintendo to make a lot of money. BoJ Governor Toshihiko Kuroda continued to signal a dovish stance, but at the same time acknowledged that the yen's plunge was not good for the economy. The yen has fallen more than 18 percent against the dollar so far this year, and forex traders are increasingly betting on the day when BoJ officials have no choice but to change their dovish stance.
Is the dollar the winner?
In today's reverse currency war, the strong dollar is undoubtedly the biggest winner. A rise in the dollar has proven to be a good thing for the Fed in 2022, as it is trying to cope with the fastest price increase in 40 years, and the appreciation of the dollar has helped reduce import inflation. U.S. Treasury Secretary Janet Yellen underscored the Biden administration's commitment to a "market-determined" exchange rate, but that didn't stop politicians from "celebrating" the appreciation of the dollar. Senator Pat Toomey, Republican of Pennsylvania, said in May that "the Fed must live up to its duty — it must stay the course, and the dollar strengthening" has played a big role in fighting inflation.
Jeffrey Frankel, a professor of economics at Harvard University, notes that developing countries, especially exporters such as Argentina and Turkey, are the most vulnerable. Many emerging economies have more dollar-denominated debt than their national currency-denominated debt, saying, "It's the worst-case scenario in the world: When you have dollar debt, your currency depreciates against the dollar." ”
It's unclear to what extent the dollar's appreciation can dampen inflation. Nathan Sheets, a former U.S. Treasury and Federal Reserve official and chief economist at Citi Global, noted that the so-called conductivity (i.e., the extent to which the exchange rate affects the consumer price index) has proven to be small. But in an era of rampant inflation, that could bring more benefits. Sheets noted that a 10 percent appreciation in the dollar that used to dampen inflation by only about 0.5 percentage points could reach "a full percentage point" today.
The "dangerous game" of currency appreciation
However, this is a dangerous game. If left unchecked, such international competition could trigger sharp fluctuations in the value of the most important currencies, hit export-dependent manufacturers, upend the financial position of multinational corporations, and divert the burden of global inflation.
The U.S. may not enjoy this advantage for long. Interest rate hikes by the SNB and the Bank of England are already putting pressure on the dollar, and ECB rate hikes are just around the corner; The dollar saw its biggest two-day drop since March 2020 in early June.
Experts warn that any government intervention carries a higher risk of failure. Mark Sobel, a former senior U.S. Treasury official and current U.S. president of the Official Monetary and Financial Institutions Forum, said: "Pegging to the exchange rate can be a very capricious and futile approach. Predicting how the Forex market will react to a given policy choice is often futile. ”
This article originated from the financial world