Currency War

Currency War

By Elvis Picardo Updated February 06, 2022

A currency war is an escalation of currency devaluation policies among two or more nations, each of which is trying to stimulate its own economy. Currency prices fluctuate constantly in the foreign exchange market. However, a currency war is marked by a number of nations simultaneously engaged in policy decisions aimed at devaluing their own currencies.

Nations devalue their currencies primarily to make their own exports more attractive on the world market.

KEY TAKEAWAYS

*A currency war is a tit-for-tat policy of official currency devaluation aimed at improving each nation's foreign trade competitiveness at the expense of other nations.

*A currency devaluation is a deliberate move to reduce the purchasing power of a nation's own currency.

*Countries may pursue such a strategy to gain a competitive edge in global trade and reduce their sovereign debt burden.

*Devaluation can have unintended consequences that are self-defeating. The worst of these is inflation. The nation's consumers bear the burden of higher prices on imports.

Understanding Currency Wars

In a currency war, sometimes referred to as competitive devaluation, nations devalue their currencies in order to make their own exports more attractive in markets abroad. By effectively lowering the cost of their exports, the country's products become more appealing to overseas buyers.

At the same time, the devaluation makes imports more expensive to the nation's own consumers, forcing them to choose home-grown substitutes.

This combination of export-led growth and increased domestic demand usually contributes to higher employment but faster economic growth.

It may also lower a nation's productivity. The nation's businesses may rely on imported equipment and machinery to expand their production. If their own currency is devalued, those imports may become prohibitively expensive.

Economists view currency wars as harmful to the global economy because these back-and-forth actions by nations seeking a competitive advantage could have unforeseen adverse consequences, such as increased protectionism and trade barriers.

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