The classic rule of currency wars is pretty easy to understand. If you are a country with a lot of debt and your debt is primarily denominated in the money your central bank prints out, you can print your way to financial freedom. That is right – just let the printing presses run, flood the market with worthless paper and you are out of debt. I have painted this picture very simplistically to dramatize the point that governments can devaluate their way out of debt.
This was done many times before in Latin America by countries ranging from Mexico to Argentina. This has happened in Europe with Italy. Devaluation has always been a very, shall we say, frowned upon practice. Still, it is one very powerful bullet in an arsenal of financial weapons central banks can use. This is the reason why the European monetary union doesn’t make any sense. You will always have countries like Greece, and to a lesser but more lethal extent Italy, that is not as financially disciplined as Germany or other northern countries.
Devaluation is a key strategy in waging a currency war. Not only are you able to get away from your debts by making them cheaper and cheaper, you can also export your way to greater prosperity. Again, when the value of your currency is low, the price of your exports become cheaper. In classic economic terms, when the price of an item becomes cheaper, the demand for that item tends to go up.
These two benefits do not escape the notice of central banks. This is precisely what is happening right now, with the European union engaging in quantitative easing following Japan’s lead. Who set the whole chain in motion? You got it: Uncle Sam. The United States went through several years of quantitative easing. Now the world is flushed with cheap money and it is blowing up stock markets all over the place. It is anyone’s guess when the other shoe will drop and somebody will have to pay the piper.
We are living in a global bubble economy. Unfortunately, the global economy is slowing down. That is the paradox behind all these stimulus schemes. It is supposed to jump-start the global economy. It hasn’t so, far. There is a lot of debate as to whether or not it worked in the United States’ case.
Leaving that aside, one key way to look at all this cheap liquidity is that there is a currency war going on. Is the United States fighting the currency war to lose? The U.S. dollar is very strong while its competitors’ currencies are very cheap. Not surprisingly, European and Japanse exports are looking attractive while American exports are looking pricey.
It doesn’t make any sense, in the midst of this currency war, for the Federal Reserve to increase interest rates. If that happens, the dollar gets even stronger. If you think the U.S. has headaches now as to its export markets, wait until you see an even stronger dollar. This can all lead to negative effects to the U.S. home economy. First, there may be wave upon wave of layoffs announced by U.S. multinational companies, followed by layoffs by big U.S. exporters. If you factor in the multiplier effect to the rest of the economy, it doesn’t look like the U.S. is fighting a currency war to win.