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Exchange Rates

The weapons and tactics of a currency war

Although the US and China have recently traded harsh words over exchange rates, experts say currency manipulation and protectionism is nothing new. If escalated, though, the fight could have disastrous consequences.

100 yuan bills

Beijing keeps the yuan weak to promote exports

Conflict is growing in the trade relationship between the United States and China, with the yuan being held at an artificially low value to secure a competitive advantage for Chinese exports.

Goods produced in a country such as China with an inexpensive currency effectively cost less when sold to consumers in a country with a higher value currency. Those goods then become desirable, helping to spur the economy in the producing country.

But China is by no means alone in engaging in this type of policy. Many countries seek to make their exports more attractive by keeping their currency weak. And there are plenty of strategies by which to do so.

Holger Bahr, an economist at Dekabank, says China isn't devaluing the yuan, but rather has been keeping it pegged to the dollar at a low rate of exchange. Instead of devaluing its currency, China simply never let it get strong.

“The Chinese have a fixed exchange rate with the Americans, which wavers very little,” he told Deutsche Welle. “There is a slight adjustment – a slight increase in value – which is determined each month.”

Chinese cars to be exported

Chinese exports are competitive because they're inexpensive

“In the end it's a decision of the government – of the finance ministry – as to what's undertaken by the central bank,” Bahr said. “Concretely put, this means that by buying or selling American government bonds, the Chinese can keep the exchange rate between the Chinese and American currencies precisely where they want it to be.”

US producers can't compete

China keeps the yuan approximately 20 to 30 percent below the level that an objective evaluation of its market position would dictate. This makes Chinese exports so inexpensive that the US complains its producers simply can't compete.

In turn, the US protects its own interests by weakening the dollar, but it doesn't do so by manipulating exchange rates. Instead, it uses monetary policies which support banks, make credit inexpensive and bolster its economy.

This jockeying for a low-ball position has seen the US budget deficit grow, while its central bank continues to print money.

Trade partners suffer

Stefan Rieke, an economist with BHF bank, says the effects are felt by neighboring countries and trade partners.

“The aggressive monetary policies of the US are above all targeted to stimulate employment in the US – to stimulate growth,” he told Deutsche Welle. “Of course this has side effects in neighboring countries and with trade partners via the exchange rate. It causes their currencies to solidify, which can be a problem.”

Dollar bills

The US supports banks and makes credit cheap to bolster its economy

The chief problem is that the many dollars printed by the US are sure to be invested somewhere sooner or later.

Many dollar-based investors have sent their money to Brazil, where it needs to be converted into Brazilian real. The increasing demand for real caused the currency’s value to increase - something the Brazilian government was eager to stop in an effort to protect its export sector. It therefore saddled foreign investors with new taxes to slow the flow of foreign capital and relive the upward pressure on the real.

Another classic strategy employed by central bankers is to sell off reserves of their own currency to lower the its value. In the past, Switzerland has done so with its franc, and Japan with its yen. Both currencies had increased in value to the point where the governments became worried about their export competitiveness.

Stability through quality exports

But currency devaluation isn't the only way to ensure sales of exports. The euro is a strong currency, but that hasn't hindered Germany's exports, which nevertheless fare fairly well.

Dollar and euro bills

The euro is a strong currency, but Germany has been able to compete

Thomas Meissner of the DZ Bank says this is because German exports are often of a very high quality, meaning foreign customers are willing to pay more for them.

"Because of its export structure – specifically when it comes to machines and facilities – Germany actually has a somewhat more comfortable situation,” he told Deutsche Welle.

“The demand for these machines is relatively stable in terms of price and therefore doesn't react so drastically when the euro gains in value. At some point there's a limit, of course. But even at the high point of $1.60 for each euro in April of 2008, the European Central Bank didn't intervene.”

Import tax would devastate

A fairly high degree of economic performance is necessary to take a relaxed approach to currency exchange politics. Whenever that level of core performance is missing, governments compensate with other measures. The US, for instance, has threatened to tax Chinese imports unless the yuan is allowed to appreciate in value.

Holger Bahr of Dekabank says such protectionist measures could have terrible consequences.

“In fact that would be a further level of escalation – a very terrible one, I believe,” he said. “There are always ideas which are protectionist in nature to put other countries in check with trade restrictions. But when one starts to erode free trade, erode globalization, erode the solid footing… that's a form of escalation which can damage global trade in the long term. The global economy wouldn't really be able to support that.”

Author: Michael Braun (gps)
Editor: Sam Edmonds

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