US President Donald Trump’s accusations that China might be manipulating its currency to gain competitiveness seem to have galvanised many countries to try the Chinese recipe in the aim of boosting growth.
This has prompted many experts to believe that the world might be heading for an all-out currency war.
Also known as competitive devaluations, currency war according to the Free Encyclopedia, is a condition in which countries seek to gain a trade advantage over other countries by causing the exchange rate of their currency to fall in relation to other currencies.
Early this month, China’s Central Bank devaluated the yuan to below 7 against the US dollar, triggering another round of heavy punches from the White House.
Escalating trade tensions are said to be taking a toll on the global economy and are partly responsible for the International Monetary Fund’s recent downward revisions to global growth forecasts for 2019-2020.
“Facing sluggish growth and below-target inflation, many advanced and emerging market economies have appropriately eased monetary policy, yet this has prompted concerns over so-called beggar-thy-neighbour policies and fears of a currency war,” Gustavo Adler, Luis Cubeddu, and Gita Gopinat, three experts from the International Monetary Fund (IMF) wrote on a blog post published on Tuesday.
Monetary easing can help stimulate domestic demand, which in turn benefits other countries by increasing demand for their goods.
“The concern, however, is that monetary easing also weakens a country’s exchange rate, making exports more competitive and reducing demand for other countries’ imports as they become more expensive—a phenomenon known as expenditure switching,” they explained.
The Financial Dictionary said monetary easing policy makes borrowing easier for businesses, which stimulates investment and expansion of operations, and immediately boosts stock prices.
In the medium term, it promotes economic growth. However, if this policy remains for too long, it can lead to a situation in which there is a glut of currency or too many dollars chasing too few goods and services, leading to inflation, it said.
Exchange rates can’t do it all, and higher bilateral tariffs are unlikely to reduce aggregate trade imbalances, the Fund warned.
“One should not put too much stock in the view that easing monetary policy can weaken a country’s currency enough to bring a lasting improvement in its trade balance through expenditure switching,” the three experts stated.
Monetary policy alone is unlikely to induce the large and persistent devaluations that are needed to bring that result.
“To be sure, the adjustment becomes more balanced over time as exports respond more meaningfully to exchange rate movements, although the full expenditure switching effect remains relatively modest: a 10% depreciation leads, on average, to a 1.2% of GDP improvement in the trade balance over a span of three years.
“So, while exchange rates facilitate durable external adjustment, the expenditure switching effect of a currency weakening, or its negative impact on trading partners, should not be overplayed.”