What is a Currency War? - Definition & History

Instructor: Morgan Gannarelli
In this lesson we will discuss what a currency war is and the history behind currency wars. We will also discuss the negative effects of a currency war and its impact on the economy.

What is a Currency War?

Have you ever read in the newspaper about the value of the U.S. dollar ''dropping,'' or about the ''strong'' Euro? Currencies change in value relative to each other for many reasons. Countries sometimes devalue their currencies, hoping to make government debt easier to pay or to stimulate their economy: having a low currency value makes exports cheaper than those of other countries and helps businesses to grow, boosting employment. If one country devalues its currency and other countries follow suit to boost their economies by shifting the balance of trade, it's known as competitive devaluation, or a currency war.

Negative Effects of Currency Wars

Currency wars are sometimes called ''a race to the bottom.'' While devaluing currency makes exports more competitive, it makes imports more expensive, decreasing citizens' purchasing power. It can also increase inflation. Currency wars tend to dampen international trade.

History

Early Currency Wars

The term currency war was coined in 2010 by the Brazilian Minister for Finance, Guido Mantega, but the process of competitive devaluation has been going on since WWI, when countries first departed from the gold standard (a system in which the country's paper money was tied to their reserves of gold) and became able to manipulate the value of currency through monetary policy. In the 1920s, Germany, France, and Belgium depreciated their currencies in order to get back on the gold standard after abandoning it during WWI. Britain did the opposite, instead raising the value of its currency; this prevented widespread currency war. In the late 1920s, however, Britain, France and the U.S. engaged in a cycle of competitive devaluation that discouraged global trade and ultimately may have contributed to the Great Depression. In 1936, the three countries agreed to stabilize their currencies, ending the currency war.

The Dollar System

In 1944, many nations got together and agreed to a mostly-fixed exchange rate tied to gold through the U.S. Dollar. This kept currencies mostly stable for nearly three decades before Nixon took the U.S. off the gold standard again in 1971. Currencies were more volatile, but currency war didn't break out because countries typically had different priorities and rarely engaged in competitive devaluation all at once.

dollar

In 1997, several Asian economies collapsed, triggering the Asian Crisis. After the crisis, their faith in free-exchange was shaken; many countries began intervening to keep the value of their currencies low relative to the dollar. China, for example, has bought more than a trillion U.S. dollars to keep the dollar strong and the yuan relatively weak.

A New Currency War?

It was in 2010 where the Brazilian Finance Minister, Guido Mantega, coined the term currency war and claimed that the most powerful nations were engaging in one, hurting Brazil and other less powerful economies by increasing the value of their currencies and making exports less valuable.

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