World Economy

Currency Wars Escalate

Currency Wars  EscalateCurrency Wars  Escalate

As we are now more than halfway into the third quarter of 2015, substantial divergence still prevails around the world in terms of monetary policy and economic conditions, with certain regions experiencing accelerated growth and several others still struggling.

Inflation has reached several decade lows despite monetary policy being extremely loose in most of the developed economies and tight in emerging economies and credit spreads are trading below default rates, while yields still remain near historic lows, Christiana Vasiadou wrote for

Such low inflation rates around the world, and disinflation caused by sliding oil and other commodity prices, have been triggering a number of central bank responses such as negative interest rates, asset purchases and FX interventions, in summary declaring 'Currency Wars'.

Countries enter a race to the bottom in an effort to boost their ailing domestic economies and growth figures by competing against each other in weakening their currency to achieve a relatively low exchange rate. This policy effectively causes countries to “steal exports” and therefore growth from their trading partners.

Devaluation Race

In recent years, countries that have been participating in a competitive devaluation race since 2010, have used a combination of policy tools, including quantitative easing, direct government intervention and imposition of capital controls.

Monetary easing measures by BOJ and the ECB, bailouts in Greece and Ireland, Chinese currency manipulation, the unexpected move of SNB to remove the 1.20 peg on the EUR/CHF pair and Sweden dropping the Swedish krona interest rate below zero, have all been indicators of the intensification of the currency wars in recent times.

China's Market Bubble

The recent burst of the Chinese stock market bubble has proved to be a major catalyst in global market developments, as it has been adding severe pressure on the Chinese economy, threatening to drag it further down to the slowest pace since 1990.

In an effort to put a brake on the stock market decline and deteriorating economic growth, China unexpectedly moved last week towards devaluating its currency, a move that has intensified the continuing currency wars. Furthermore, as the latest figures issued Friday morning indicate that manufacturing activity in China has reached a six-year low, the possibility of further currency devaluations in the near future is high.

Escalating Risks

In order to draw the whole picture, there are four major risk factors that are responsible for currency devaluation moves in the developing economies: (1) the slowing growth in China resulting in devaluation of the yuan, (2) the collapse of oil prices (3) the possibility of US interest rate hikes and (4) the continuing severe recession in Russia. All of these factors are interrelated and affect the economies of various developing countries in a combined manner.

Kazakhstan’s move to abandon its currency-band exchange rate mechanism and adopt a free-floating exchange rate, is the latest sign that emerging countries will not defend their currencies any longer after China shocked the global markets. This has triggered a 23% decline in the tenge to a record low of 257.21 against the US dollar, after its central bank had already spent a staggering amount of $28 billion to defend the currency during 2014 and 2015.

This news hit the markets just one day after Vietnam's latest devaluation of the dong, the third adjustment so far for this year.

Global Markets Rout

Last week’s devaluation of the yuan triggered a storm of declines in the range of 5% in most emerging market currencies which had already been at multi-year lows, from Russia to Turkey and Malaysia. There are several other countries exporting goods to China that are at risk as a consequence of the yuan’s devaluation, including Brazil, Peru, Thailand, Taiwan, South Korea and South Africa. The South African rand slumped beyond 13 against the US dollar for the first time since 2001 while the Brazilian real has been the greatest loser of the developing nation currencies this year. The Turkish lira fell to a historic record low and the Malaysian ringgit traded at a 17-year low.

Nigeria and Egypt are two countries heavily exposed to oil, which have so far resisted entering the currency revaluation arena, mainly for political reasons.

By applying competitive devaluation, all of these emerging countries have an opportunity to “import” growth from developed economies.