Currency Wars and Protectionism: Managing the Euro - Coursework Example

Currency Wars and Protectionism; Managing the Euro Affiliation Currency Wars and Protectionism; Managing the Euro After mounting an intervention to handle the effect of the recession, various countries have taken concrete steps to fight the resulting fluctuation of their currencies. These countries are seeking to fight the undesirable side effects that a currency war would have on their trade competitiveness. However, extraordinarily loose monetary policies in the developed economies and consequential international search for yield are operating to promote the value of emerging currency wars. For instance, several countries are increasing their efforts to fight currency appreciation and depreciation. As others strike back in these worldwide currency wars, the practical phantom threat is resurgent protectionism that make countries in crisis to face difficulties in exporting their way out of recession (Marcelo 2010: 19). However, if countries embark on mercantilist beggar-thy-neighbor policies, this will cause lose-lose condition for the global economy. Many countries are in the middle of an international currency war, which means a broad weakening of the currency. This situation threatens the economy of these countries because it takes away their competitiveness. Meanwhile, currency wars are a zero-sum game and may easily degenerate into a negative- sum game also referred to as prisoner’s dilemma (Marcelo 2010: 20). What may seem reasonable for one country in isolation may turn out to be bad for other economies. According to Marcelo (2010), Brazil’s finance minister referred currency war as monetary and exchange rate policies formulated to decrease the value of one’s currency. Many countries in late 2010, had formulated strategies that would put downward pressure on their own currencies. The policies that tend to promote economic growth in ones country regardless the growth in other counties are referred to as beggar-thy-neighbor monetary policies. For instance, central banks of Japan, Taiwan and South Korea during late 2010 intervened in currency markets in an attempt to generate cheaper currencies. Similarly, china was maintaining the value of the renminbi from rising, U.S. monetary policies and eurozone were extremely expansionary. Therefore, all these policies had chances of putting upward pressure on other countries’ currencies. Mantega argued that emerging markets were being destabilized by depreciating U.S. dollar and an appreciating of Chinese currency. The setback of the currency wars is that the empire strikes back. Tit for tat policies can eventually overturn into lose-lose results on the global scale, where all countries are worse off. For instance, the protectionist trade strategies in the 1930s were painfully demonstrated, as they assisted to change the recession into an international depression (Wheatley and Correspondent, 2011). By decreasing the rate of interest and leasing a flood of liquidity, U.S. might be capable to make other currencies appreciate against a dollar that would make their exports cheaper. However, countries such as Brazil and China condemned the U.S. for its quantitative easing policies and argued that their actual intension was to devalue the dollar. Fortunately, international trade protectionism has greatly been avoided in the aftermath of the 2008-2009 global crises so far. However, the increasingly trend of currency intervention as an active policy engine could cause critical threats to the global economy (Stiglit 2010: 60). Meanwhile, varieties of countries are at the verge of shifting to a diverse regime of controlled exchange rates and fragmented capital markets. The move is not due to extensive deliberations over what system would be best to all. However, some countries embarking on actions believe in their own interest, without considering others who employ strategies in order to protect themselves. The U.S. monetary policy caused the bubble whose breaking resulted to the global recession. Meanwhile, it caused Latin America’s to decline because unprecedented increase in interest rates caused severe debt crisis during early 1980s. The U.S. benefits of the flood of liquidity policy are little, and it is putting global stability in danger. Large and immediate adjustment in exchange rates can cause devastating effects, especially in developing countries because firms are forced into bankruptcy. These developing countries have been the source of global growth, and these policies could destroy any hope of a fast global recovery. Various countries are pursuing their own interests. For instance, U.S. worries about unemployment and china is concern about its undervalued currency that could cause economic disorder. If countries opt to continue with this trend of protectionism, the merging economies is threatened with an onslaught of capital that protect them via taxes, capital controls regulations and direct interventions. This will cause an increase of fragmented global financial market with almost unavoidable spillovers into protectionism. Brazil may be the most current and visible example of a country that is actively looking for policies to fight currency appreciation. However, it is not alone because Japan, Korea and China with their long-standing currency policies, put effort to offset the strengthening of the national currency are becoming more popular. According to Dadush and Vera (2011:7), currency tensions are currently the significant topic in gatherings of international talking heads. However, unilateral currency intervention might prove ineffective at best and outright harmful at worst in case global forces work in the opposite direction. Therefore, in currency wars the force requires to operate within countries. After all, exchange rates are essential parts required in global adjustment, if global rebalancing means a general appreciation of resulting market currencies against currencies of developed economies (Stiglit 2010: 45). In case, a single country blocks the adjustments, it makes it difficulty for other economies that requires bearing a greater burden of the global adjustment. Exchange rates are relative prices. Therefore, one currency’s weakening indicates that another currency strengthening. Based on the mercantilist reasoning, a single country may seek to gain international trade competitiveness by promoting a weaker currency (Evenett, 2011). However, if other countries do the same, no one gains anything because the international economy is regarded as a closed system. In a stimulated global currency environment, the policy makers are threatened by the undesired side effects that persist and significant currency can lead to the lack of trade competitiveness for the local manufacturing firms. In the past, a powerful currency has assisted to enhance competition from imports, but also has destabilized export competitiveness in external markets. Therefore, most manufacturing industries have started complaining about lack of competitiveness related to a powerful currency. Meanwhile, policymakers hope favorable exchange rates would stabilize America’s economy, but weakening the dollar to promote exports is a risky strategy (Huang 2012: 56). This would cause exchange rate volatility, protectionism and invite a reaction from competitors. During this weak global economic environment, a currency war will make every country a loser. Judging on the china situation, controls on capital flows can have a temporally impact, but over time restrictions often become absorbent. For instance, the protectionism concept via monetary policy used by China and the U.S. leads to currency war. When Brazil multiplied its tax on foreign buying of local bonds, people argued that it was taking defensive action against a subsequent quantitative easing (Capie, 2003). The speculation argued it was a weakening of the dollar that might be engendered by Federal Reserve’s enthusiasm to introduce money into the markets by purchasing up bonds. Currency wars are a significant concern in the international environment because this tensions are caused by misguided of domestic policies in the global potential economies. The policymakers argue that this can be managed via incremental changes by the European Union, U.S. and China as well as not to overhaul the exchange rate system. In order to manage the euro to prevent currency wars, ECB opt to start purchasing unlimited sovereign bonds from crisis stricken countries. This will be possible if these countries have already requested help from the eurozone rescue fund and adhere to ECB conditions. In order to lend the last resort in the government bond market, ECB prevented a fear that would have pressured the government into liquidity and solvency crises. Meanwhile, a significant change in the governance of the eurosystem helps to manage euro. The ECB focuses on price stability and maintaining a proper transmission of monetary policy (Berger 2004: 67). In order to make the monetary policy effective, ECB is forbidden from buying bonds directly from government but can buy on the bonds markets. High interest rate on government bonds makes borrowing more expensive for business and consumers. Thus, ECB should accept the differing interest rates that undermines the single monetary policy or acts to restore the normal transmission of monetary policy across the whole eurozone. According to Bundesbank president Jens Weidmann, ECB bond buying would assist eurozone government by decreasing interest rates on those bonds. This would result to fiscal policy and not monetary policy that makes it operate outside the ECB’s authority. In the august 2012, the governing council of the ECB took decisions on several technical features. This was based on eurosystem’s complete transactions in secondary sovereign bonds markets that aim at safeguarding a suitable monetary policy transmission. Thus, a compulsory condition for this policy is strict and effective conditionality attached to a suitable European financial stability facility/ European stability mechanism (EFSF/ESM) programme. These programmes can be in the form of a full EFSF/ESM macroeconomic changes programme or a precautionary programme if they comprise the chances of EFSF/ESM primary market purchases. These programmes and policies employed by ECB have unlimited intervention to protect the euro from the struggling eurozone members. However, emerging markets have become increasingly to criticize the policies that are regarded as currency manipulation. Meanwhile, efforts to reform the international monetary system should consider the flexibility of the system during the crisis and changes required are incremental and not revolutionary. Bennett and Keene (2011) indicate that effective management of the euro would make Europe a powerful in a competitive globalized world that would unite European economies. This could oblige countries to limit their debts and deficits guarantee that no country would be accountable for the debts of another that enhance political unity. Meanwhile, in order to manage euro effectively, ECB can opt to use sovereign wealth funds (SWF) that is a state owned investment fund composed of financial assets like stocks and bonds among others. The SWF aims at protecting and stabilizing the economy from excess volatility in exports that prevent currency wars. For countries to export their way out of recession, they should have mutual commitments to structural reforms, fiscal expansion and correcting trade imbalance. Therefore, each country is supposed to determine the best way of attaining agreed goals with attention to negative and positive externalities. They should avoid protectionism that threatens the countries in crisis because it makes them encounter difficulties in exporting their way out of recession. Bibliography Bennett, A & Keene, T 2011, China Managing Euro Similar to Dollar Peg Policy, BofA’s David Woo Says - Bloomberg. Bloomberg - Business, Financial & Economic News, Stock Quotes. 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