“Currency wars” is an emotive phrase, carrying the implication that recent attempts to prevent currency appreciation are a dangerous step towards 1930s-style trade protection. What is the risk that the Swiss National Bank’s declared intention to buy unlimited quantities of foreign currencies to support a peg to the euro will lead in that direction?
The suggestion, which has been widely mooted, is unduly alarmist. There are two separate forces at work in the markets. One concerns countries such as Brazil, Turkey and Chile which are perceived by global investors as exciting destinations for portfolio and direct investment. Large capital inflows have tended to unbalance monetary systems and asset markets, while reducing the competitiveness of exports as these countries’ exchange rates are forced up.
Then there is the different problem of currencies that provide a haven against the uncertainties aroused by the eurozone sovereign debt crisis and weak fiscal management. If, as in the Swiss case, there is a large currency overvaluation, reserve accumulation to stabilise the exchange rate may be justified, as the latest OECD Economic Outlook acknowledges. In fact a process is under way, which started with Japanese unilateral action on the yen in August, whereby haven countries are trying to shed their haven status.
Yet there are costs. For the Swiss the risk is of accelerating inflation. For everyone else the worry is that last week’s dramatic market intervention will be destabilising in currency and bond markets, while putting more pressure on other havens such as Norway and Singapore. The volatility and instability will be all the greater if the markets choose to test the resolve of the Swiss National Bank, forcing it into drastic reserve accumulation.
There is an obvious case here for international co-operation to stabilise currencies. Yet the political will for it does not exist, so market conditions will remain volatile. But that need not mean a return to the 1930s. Then, the countries that resorted most to trade tariffs and quotas were members of the gold bloc who were trying to avoid devaluation, while struggling with savage deflation. This is far removed from the plight of haven countries or the emerging markets whose currencies have soared.
That said, it is profoundly disturbing that global capital has so lost faith in the management of currencies and economies. The precipitate flight to safety is a dismal verdict on the policymakers.
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