The currency war between China and USA

Recently, the global currency war has become a hot issue to most of the people and has been making headlines around the world. As we can see, most of the headlines of the newspapers and magazines like the Financial Times, Telegraph and The Economist are about the currency war. On 27 September, the Brazil’s finance minister, Guido Mantega was the one who declared that “an international currency war has broken out and this happens because governments around the globe now are competing against each other to depreciate their exchange rate in order to boost competitiveness” (Financial Times, 2010). For example, countries like South Korea, Japan and Taiwan are putting effort into lowering their currencies. However, the main attention was given to the two economic superpowers; China and United States of America. Today’s global currency war happened two years after the global financial crisis 2008 and it involved mainly China and USA. Why is the currency war happening? The causes and effects of the currency war will be mainly focused and discussed below.

There are several factors that need to be considered to the causes of the currency war. Firstly, countries like Japan have carried out an explicit currency intervention or monetary easing in the exchange market and this causes their currency, yen, to be weakened and remain low against other major currencies. Other countries like Brazil and South Korea have also done the same. Their currencies appreciation have stopped because they have been doubling up the taxes on capital inflows in order to maintain their values of currencies low to boost their exports. If their currencies are lower, the demand for export will go up because it will be cheaper for other countries to purchase their exports. When most developing countries favored the depreciation in their currencies, other currencies like the euro and US dollar will tend to appreciate. This will cause a problem for the European government to control their finances as they are already in a troubled-state.

Secondly, the financial crisis that happened at the end of the year of 2008 has caused United States’ economy to be in a deep recession and actions have been taken by the US government to crawl out of the recession. Currently, the United States is still in its economic recovery state after the crisis but the high rate of unemployment has worsened its recovery. This is why US focused on China’s unwillingness to let their currency, yuan depreciate. The currency war between China and USA then started when the US government blamed China for not letting its currency appreciate. The US treasury secretary, Tim Geithner said that China has created “a dangerous dynamic of competitive non-appreciation in emerging economies because China refused to raise its value of yuan” (The Economist, 2010). There were some analysts who insisted that the depreciation of yuan was the major reasons for the US slow economic recovery as yuan is traded up to 25% below its true market rate in which the Chinese exporters were given unfair advantage. They even thought that millions of the US job losses are caused by this factor. The US government also claimed that China is manipulating its currency by keeping its currency, ‘yuan’ undervalued against US dollar in order to allow its exports to remain competitive. When China holds the value of yuan down against US dollar, the costs of goods of China in USA will be lower and this contributes to a trade imbalance. This also results in an increase of the US trade deficit with China because the lower value yuan gives an advantage to the Chinese exporters and manufacturers. A few months ago, China released its currency peg to dollar to prevent a large scale appreciation on its currency. Hence, yuan is kept at a 0.5% daily trading band and will remain unchanged (Hurriyet Daily News, 2010). Furthermore, the US Congress bill asked for extra tariffs to be placed on Chinese products but China argued that it is against the World Trade Organizations'(WTO) rules to do so.

On the other hand, the currency war is not only caused by the China’s manipulation on its currency but also by the US. China has warned US not to use the dispute over the value of yuan as a “scapegoat” for its high unemployment and deteriorating growth prospects (Telegraph, 2010). Meanwhile, China responded to the US that the biggest distortion came from their ultra-loose policies and blamed US Federal Reserve as well for confirming its launching of the second quantitative easing (QE2) .In this quantitative easing, the US will pump an extra $600bn into the market and the money supply is increased but created by nothing(Financial Times, 2010). The printed money is then used to buy financial assets like government bonds. This has obviously showed the sign that US wanted to devalue its dollar. The US Federal Reserve has taken into account to carry out the expansionary monetary and fiscal policies so that they can increase their cash flow and liquidity in the market to reduce the long-term interest rates and hence, contribute to a recovery. By doing so, the US can devalue their dollar too.

Nevertheless, the depreciation of US dollar put pressure on other countries because it affected their exports and finances as their currencies appreciated constantly. This is the reason why many countries are keeping their value of currencies low (Telegraph, 2010). The governor of China’s central bank, Zhou Xiao-chuan said that, “the massive liquidity creation would swamp emerging economies with destabilising capital inflows”. China wanted to prevent further damage that will be caused by the depreciation in US dollar, so it tended to hold its currencies down. Moreover, Yao Jian, the Chinese Ministry of Commerce spokesman has indicated that a large rise in the value of yuan will definitely have a negative effect on Chinese exports. Thus, a stable yuan exchange rate is vital for the domestic consumption and for the stability of the world’s economy (Telegraph, 2010).

In spite of that, the global currency war between China and the United States of America will have huge implications on the global financial systems and everyone one of us. The currency war has threatened global economic recovery and it causes global inflation. Most of us knew that if the QE2 is launched, there will be a large flow of capital to most of the developing countries and the US dollar will depreciate. This will lead to an excess of money in the country that received it and puts pressure on the consumer prices and in the long term, the value of the assets will increase. There will be a serious speculation of hot money when the government does not intervene in the market. This is because the large amount of money which is known as hot money will generate the new bubbles in stock and real estate markets of emerging and developing economies (People’s Daily, 2010). The hot money can be defined as the money that flows out of the The quantitative easing will also drive the interest rates low to create more credit. With the depreciation of the dollar from the quantitative easing, it forced other countries’ currencies up and resulted in putting the inflationary pressures on these countries. The Chinese Securities Journal stated the efforts that the US put in weakening its currency will push up inflation as well as the stock and property prices because there are higher global commodity prices and fuel money that flow into the emerging market (Hindustan Times, 2010). The inflation is known to destroy the real wealth and jobs not creating them; it also causes problems to the globe.

In addition, the World Trade Organization (WTO), Organization for Economic Cooperation and Development (OECD) had stated the currency war will increase protectionism. Protectionism is a kind of measure that protects the economy by reducing the imports. There will be an increase in the protectionist barriers like higher tariffs that will be placed on exports, quotas, embargoes, voluntary exports restraints and various restrictions on the international capital flows. Other countries will switch to purchase exports from countries that incurred low tariffs on their goods as the costs are much lower. Consequently, world trade will collapse and this leads to a depression and deflation.

Lastly, the currency war has affected the relationship between US and China and is transforming the currency war into a trade war. A year ago, the US hoped to have a friendly relationship with China but now there seems to be tension due to the currency war and US accusing China of exchange rate manipulation. The slowing of the recovery of the economy will be enormous if both countries became enemies and started to threaten each other.

In conclusion, there are many news and articles that shown that US was the one who is responsible for the currency war. I personally think that there will not be any winner for this war because it involved two powerful countries which are interdependent. It is very obvious to everyone that this war has created a huge impact on our global financial economy and its consequences if this crisis is worsened. Hence, it is vital that the governments should take drastic actions to solve this issue.