Currency Crises and Wars - Research Paper Example

Currency Crises and Currency Wars Currency war is a practice that involves devaluation of a currency by a country so as to increase its exports in the world market. This paper aimed at providing detailed information on provided detailed information on how China and the U.S. have contributed to currency war. It also established factors that have contributed to the changing value of currencies. Additionally, it expounded on the key contributing factors of currency war and currency crises along the effects of currency devaluation to the ongoing currency war. This study also provided detailed information on how other countries are affected by the characters of countries such as the U.S. and China. The method used for this study was descriptive analysis. The results collected showed that the behavior of the U.S. and China facilitate the spread of currency war. The results were presented in the form of charts to enhance quick understanding. CHAPTER 1: INTRODUCTION 1.1 Background study A currency war is a term that was coined by Guido Mantega in late 2010, to describe the competition of countries that result to a relative low exchange rate for the countries’ respective home currency. Countries devalue their currencies by printing more money, quantitative easing, lowering interests needs, buying other country’s debt, buying other country’s currency, or by limiting the flow of domestic currency in and out of the country’s economy via taxes, tariffs, and volume restrictions. In most occasions, countries devalue their economy so as to boost their exports and employment. However, its negative effects outdo its advantages. For instance, it leads to inflation, direct large costs, and retaliation by other competitive countries. On the other hand, currency crisis result from a drop in value of a country’s currency. This decline is associated with instabilities in exchange rates in a given state; one unit of the currency fails to buy the quantity of goods it used to buy before. When faced with such a crisis, central bankers try to withhold the current fixed exchange rate by either utilizing the country’s foreign reserves or allowing the exchange rate to fluctuate in order to raise domestic interest rates so as to defend the currency. Currency wars and currency crises have close relationship. For instance, “when the market expects devaluation, downward pressure placed on the currency can really only be offset by an increase in the interest rate” (Fourcans & Frank, 2003). For the rate to be increased, the central bank has to reduce the rate of the money supply, which as a result raises demand for the currency. The bank achieves this by creating room for capital flow through selling off foreign reserves. Currency wars have the potential of causing a severe currency crisis. “This is evidenced by not only their ability to steal growth from other trading partners, but also degenerating into sequential spells of inflation, recession, retaliation, and sometimes actual violence” (Rickards, 2011). 1.2 Research problem The world is under attack of a severe war that needs to be combated before it halts the progress of world market. However, its spread is catalyzed by the behaviors of largest nations in the world. The participation of superpowers in it can make other nations to take part in it so that they can survive. Unfortunately, its practice affects the disadvantaged countries such as Brazil. 1.3 Purpose This study purpose was to explore the role played by key nations such as the U.S and China towards the emergence and advancement of the currency war. It also aimed at providing detailed information on the nations that contribute immensely towards currency war. 1.4 Objectives of the study 1.4.1 General objective To establish the correlation between currency crises and currency wars. 1.4.2 Specific objectives i. To establish the trend on how China and the U.S. have contributed to currency war ii. To establish the factors that have contributed to the changing value of currencies iii. To determine who is doing how much towards currency wars and currency crisis iv. To find out how the devaluation will contribute further to the ongoing currency war 1.5 Research questions This research will seek to answer the following questions: i. How have China and the U.S. trend contributed to currency crises and currency war? ii. What are the factors that have contributed to the changing value of currencies? iii. Who is doing how much towards currency wars and currency crisis? iv. How will devaluation contribute further to the ongoing currency war? 1.6 Significance of the study The main hope of the study is that it contributes to the understanding of the responsibilities played by superpower nations towards currency war. It is also hoped that it results to the understanding of the role of devaluation of currency to currency war. CHAPTER 2: LITERATURE REVIEW According to Kouretas and Papadopoulus (2014), the world has been in many wars including world wars. Rickards (2011) also concurs with Kouretas and Papadopoulus by claiming that the occurrence of currency wars is often associated with something that is not beneficial. From Kouretas and Papadopoulus explanation is evident that the world is currently experiencing a new type of war, a war different from what majority of the people know; the currency war. “Though the world experienced a series of competitive devolutions in 1930s, the term currency war originated from Guido Mantega, Brazil’s finance minister, at the recent International Monetary Fund (IMF) congregation that was held in Washington DC” (Hutchison & Center for Pacific Basin Monetary and Economic Studies, 2001). According to Rickards (2011), the term currency war stood for a series of devaluation of currencies by states to enhance their success in market competition. In connection with his argument, Fu (2012), Voda (2012) and Sharma (2011) claim that it is evident that global current account imbalances have the potential of developing into an open trade war. Kouretas and Papadopoulus (2014) further claim that there is likelihood of the currency conflicts triggering the emergence of a severe crisis. Fu (2012), Voda (2012), Sharma (2011), and Kouretas and Papadopoulus (2014) arguments however are exclusively comprehensible. This is justified by the fact that in an epoch of decline in demand, issuers of reserve currencies are enforced to adopt monetary expansion whereas non-issuers respond by means of currency intervention. According to Kouretas and Papadopoulus (2014), the countries that are not among the former or the later are enforced to cope up with soaring currencies. For instance, Brazil is one of the countries that are experiencing challenges from inflow of speculative capital leading to it raising its currency and weakening its competition power in the world markets. Rickards (2011) also postulates that Brazil is forced by countries worldwide to lower down the value of its money in order to be able to sell its products in foreign markets. According to Rickards (2011), currency war is just like other wars because it has specific leaders; USA and China. According to him, the US has been condemning China for stage-managing its exchange rate. In tandem to this, the experienced uncontrolled financial crisis and decline in domestic demands have made most of the Western nations to quest for exports as well as focusing on the devolution of currencies (Hutchison & Center for Pacific Basin Monetary and Economic Studies, 2001). According to them, the USA aims at raising the renminbi which it thinks to be undervalued whereas China is working hard to avoid this from happening. According to Murphy and Yuan (2009), the currency conflict that led to the recent International Monetary Fund (IMF) meeting is not the first; there have been such currency conflicts before. “For instance, 25 years ago (September 1985) the governments of France, West Germany, Japan, the US, and the UK met at the Plaza Hotel in New York and agreed to push for depreciation of the US dollar” (Murphy & Yuan, 2009). Murphy and Yuan, also claims that a similar meeting was also med in August 1971 with an aim of controlling currency war. During that meeting, the US president Richard Nixon enforced the “Nixon Shock” that levied not only 10% import surcharge, but also ending the dollar convertibility into gold. From all these incidents, it is evident that the US wants to depreciate its dollar (Murphy & Yuan, 2009). Unfortunately, it has the same desire today (Cooley, 2008). However Hutchison and Center for Pacific Basin Monetary and Economic Studies (2001) argues that the current currency war is slightly different. According to them, it focuses on a nation not allied to the US, but the world’s probable superpower, China. From this, it is evident that when such superpowers fight, bystanders are often trampled. According to Hutchison and Center for Pacific Basin Monetary and Economic Studies (2001), there are diverse facts on the ground that justify that the current world is experiencing currency wars. For instance, they claim that none of the six known giants in terms of income generation (the US, Japan, Germany, France, the UK and Italy) had its gross domestic product in the second quarter of the year 2010 back to what it had in the first quarter of 2008. In connection to this, Jensen and Weston (2012) and Cooley (2008) expounds on how these economies are currently operating below their past trends by about 10%. According to them, one sign of the excess supply is the drop in core inflation to approximately 1% in the US and the countries that use euro as their currency: deflation beckons. These countries wish for their economy to be expanded by their exports. This is evident in countries such as the US that suffer from trade deficits and those with surplus products such as Germany and Japan. However, Jensen and Weston (2012) and Cooley 2008) argues that this can only happen if the growing economies will incline to current account deficit. According to Fourcans and Frank (2003), the effort put by private companies is also diverting towards the current account deficit. This is evidenced by the forecast of April 2010 by the Washington-based Institute for International Finance. According to it, the external private finance of the emerging countries was expected to be $746bn, a partially offset of about $566bn. However, the current account surplus of about $320bn, capital inflows, and the external balancing of the emerging world will lead to a surplus of $535bn (Weston, 2012). Kouretas & Papadopoulus (2014) claim that most countries are fighting for a weak currency so that their exporters will not only take part in the world business, but also contribute towards growth of the manufacturing sector alongside creating employment opportunities. However, “the Chinese involvement in the currency market has led to huge Chinese trade surplus and increasing US trade deficit by selling renminbi and buying dollars” (Beattie, Cadman and Bernard, 2010). This intervention has made China to accumulate $2.6 trillion. From this, it is evident that the currency wars are also caused by the build-up of foreign currency reserves. For instance, “between 1999 and 2008, the world official reserve had risen from $1,615bn to $7,534bn, a staggering increase of $ 5,918bn” (Moosa, 2012). This increase in foreign reserve was probably a way of overcoming future crises. However, the reserves were used up during the crisis of 2008 and 2009. Despite the effects of currency wars since 1985, “international tensions surrounding currency competition, and dollar’s privileged status, were apparent at the G20 Summit in Seol in November 2010” (Bryan, 2011). To combat this, the U.S. central bank-the Federal Reserve- decided to purchase government bonds in what it termed as quantitative easing. In addition, the Obama administration also planned to use the Seal G20 Summit in waging its own currency war against China by applying pressure on it so that it can increase the value of its currency, the renminbi, and as a result lead to the depreciation of the dollar. According to Men and Shen (2014) and Kaminsky, Lizondo, Reinhart and World Bank (1997), the U.S contributed significantly towards the rise of currency war. In their argument they expounds on how Obama failed to address China’s issue directly and thought of coming up with new rules that will oblige countries to regulate their trade surpluses. According to them, the position of China in the meeting that was held in Soul could not allow the U.S. proposal to succeed. To expound on this, Krugman (2000) also explains on how countries such as Germany and Brazil denounced the effects of depreciating the dollar on their own economies. To make matters worse for the U.S., the Chinese officials joined and interrupted the efforts put by the U.S. towards coaxing other nations into pressuring China. According to Fourcans and Frank (2003), “if all currency intervention were to cease, we estimate that the U.S trade deficit would fall by 1 to 2 percent of gross domestic product.” Additionally, it is evident that over 2 million jobs would be created. Fourcans and Frank (2003) also claim that the United States is greatly suffering because it is the leading non-aggressor. From their argument therefore it is evident that economic aggression is the main cause of unemployment in the U.S. CHAPTER 3: RESEARCH METHODOLOGY 3.1 Introduction This section explores the study design employed, techniques used in the selection of the population, analysis, and sampling of the selected group from population. The collection of data and data presentation techniques used in the study are also explored. 3.2 Research design The study involved a descriptive research design of cross-sectional type. Mugenda and Mugenda (1999) assert that a survey is a means of collecting information about a large group of elements referred to as a population. A survey has three characteristics; to produce quantitative descriptions of some aspects of the study population in which case it is concerned either with relationships between variables, or with projecting findings descriptively to a predefined population. Data collection is done by asking people structured and predefined questions and data is collected from fraction of the target population (Komba and Tromp, 2006). However, this study used secondary data. 3.3 Population and Sampling 3.3.1 Target/ Accessible Population This study was conducted between the U.S. and China. The two countries were chosen because they are the world’s largest exporters and importers. 3.3.2 Sample The sample chosen for this study consisted of two superior countries in the world. This sample size was chosen with respect to accessibility, time requirements for the study and the need for thorough analysis of the sample under study. 3.3.3 Sampling techniques Sampling design is a process of selecting a number of individuals or items from the population such that the selected groups contain elements representative of the characteristics found in the entire group (Kombo and Tromp, 2006). Probability random sampling strategy was made used. That ensured the selection of an appropriate sample of the study. 3.4 Data Collection 3.4.1 Instrumentation The main data collection technique to be utilized in the study is document analysis. The selection of the data collection methods is based on the objectives of the study, the nature of the data to be collected and the time available for the study. 3.5 Data Analysis This study made use of descriptive data analysis technique due to the qualitative nature of the data collected by the researcher. 3.6 Data presentation The findings were presented using graphs. 3.7 Assumptions and Limitations The assumption for this study was that the U.S. and China are the leading exporters and importers in the world formed enough ground for the extrapolation of the results to represent the whole world. The limitation inherent in this study was that some errors may occur because China and the U.S. also trade with other countries in the world. Additionally, the currency war between China and the U.S. may not affect other countries in the world. CHAPTER 4: DATA ANALYSIS AND INTERPRETATION 4.1 Introduction The chapter focuses on giving the findings that answer the objectives of the study. It also expounds on the impacts of currency war between China and the U.S. to the current currency war in the world. Additionally, it provides detailed information on how the currency war and crises between China and the U.S. is likely to cause severe currency war in the future. From the trend and internet sources, it is evident that the economic behaviors such devaluation of currency, reserving of resources, and the increase of exports of China and the U.S. have caused the currency war in the world. There is also great possibility for their economic behaviors to affect other nations in future. To meet its motives, China is manipulating the value its currency. Currently, it has exceeded the limits that were used in determining currency manipulation in the past. Unfortunately, this currency manipulation results to not only trade imbalances between China and the U.S., but other developing countries. For instance, the bilateral deficit with China has led to startling of the U.S. gross domestic product (GDP) by 6%. This deficit is likely to affect both the United States and its trading allies. Unfortunately, China’s currency policy aims at not reducing this deficit any time soon. The table below shows how China has manipulated its currency in order to succeed economically. The main argument postulated by this table is that China has been fixing the value of its yuan so as to increase its exports. This trend has been one of the major causes of currency war. The report also found out that the U.S. has also contributed largely in the current world Currency war by its attempt to reduce the deficit in its current account. The table below shows the trend and the deficit in the U.S current count. The implementation of the export policy by the U.S as stipulated in the table above has contributed immensely towards the U.S. exporting a lot of exports. To achieve this however the U.S devalued its currency, a practice that contributes immensely to the emergence of currency war. Besides the U.S. practice of devaluating its currency for exports purposes, other countries such as Indonesia, Malaysia, Thailand, Korea, Singapore, and Philippines have also contributed to the occurrence of currency war. The table provides detailed information on how other countries have devaluated their currency in order to increase their exports. Indonesia Malaysia Thailand Korea Singapore Philippines Exchange Rate Elasticity of Export (Long Run) -0.32 -0.53 -0.99 -0.52 -0.21 Depreciation of Asian Currencies -56.3% -27.2% -19.1% -19.8% -2.7% -26% Estimates of Export Increase 18.0% 14.4% 18.9% 10.3% 0.57% Export Volume Changes in 1998 +26% +13.4% +29.6% +2.8% Retrieved from http://www.china-review.com/sao.asp?id=2536 The table below expounds on how China contributes to the advancement of currency war by reserving a lot of its currency. From the table above, it is evident that China’s banking assets has doubled for the last four years. Its current assets stand at 147 trillion, whereas that of the U.S. has much lower assets than this. The main reason for China to employ this method is for it to compete effectively in the world market. It also aims at devaluing the dollar so that its currency can be used in the world market. Decline in the key products in the world also contributes to the emergence and advancement of the currency war. For instance, the decrease in production of oil by Arab countries leads to the increase of the fuel prices which as a result leads to countries in less developed countries to devalue their currency so that they export more of their products and as result afford to purchase the oil. Additionally, it leads to other countries to regulate the flow of their source of power so that the U.S. can utilize its resource reserve. Such conflicts among nations result to currency war. CHAPTER 5: CONCLUSION AND RECOMMENDATION 5.1 Conclusion In conclusion, currency war is a practice that involves devaluation of a currency by a country so as to increase its exports in the world market. Devaluing of a currency involves printing of more money, quantitative easing, and lowering of interests needs. Other countries also devalue their currency by buying other country’s debt and currency alongside limiting the flow of their domestic currency via taxes and tariffs. It has diverse advantages to the countries that participate in it; it boosts countries’ exports and increase employment opportunities. However, it has also many cons. For instance, it leads to inflation, direct large costs, and retaliation by other competitive countries. Currency war originates from currency crisis which result from a drop in value of a country’s currency. In tandem to this, this study provided detailed information on how China and the U.S. have contributed to currency war. It also established factors that have contributed to the changing value of currencies. Additionally, it expounded on the key contributing factors of currency war and currency crises along the effects of currency devaluation to the ongoing currency war. This study also provided detailed information on how other countries are affected by the characters of countries such as the U.S. and China. Countries such as Brazil are forced to devalue their currency so that they can sell their products to the world market. Currency war is also caused by the decline in production of key resources such as oil. Decline in oil production leads to increase in prices, and since it is one of the key elements of productivity, countries are forced to devalue their currency so that they can afford it. 5.2 Recommendation Since devaluation of prices and reservation of resources contribute to occurrence of currency crises and currency wars, economies should come together and come up with a policy that will aid in the prevention of states currency devaluation. It is also crucial for the price of oil products to be kept constant so that less developed countries can manage to grow economically. Thus, amicable measures should be taken towards regulating the prices of oil products. Nations also need to come together and lay measures that will call for China and the U.S. to stop reconsidering only their own desires in the world market. References Cooley, J. (2008). Currency Wars: Forging Money to Break Economies. New York: Constable & Robinson Limited. Ervin, J. & Smith, Z. (2008). 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