Everyone loses in a currency war

To President Donald Trump, and any other Group of 20 chief thinking about waging a currency war: It’s basically impossible to win.

That’s partly because they don’t really happen in practice. If they did, everybody would lose because everyone would play. The surest way to affect the relative value of an exchange rate is through nudging interest rates up or down.

These days, monetary policy among most major economies is so aligned that any one country would be hard-pressed to notch any kind of victory for very long. Failing to grasp this risks misunderstanding how interconnected global capital flows and commerce have become — regardless of spats about tariffs and talk of a technological cold war between the US and China. The term “currency wars” was popularised by former Brazilian finance minister Guido Mantega in 2010. It captured a global anxiety that gathered pace in the aftermath of the financial crisis, when the world’s biggest central banks pumped billions of dollars into the economy through quantitative easing.

The concept has been in remission over the past few years, as monetary policy started returning to normal.

Leave it to Trump to revive it. Over the course of his presidency, Trump has railed against what he sees as the dollar’s strength. To his credit, a model by the International Monetary Fund suggests the dollar is overvalued by 8 per cent to 16 per cent.

This criticism has only been compounded by his complaints that the Federal Reserve isn’t cutting rates — a move that tends to make the dollar less attractive. To this end, Trump slammed European Central Bank President Mario Draghi for flagging rate cuts, which could weaken the euro relative to the dollar. The president then appeared to fantasise about hiring him to replace Fed Chairman Jerome Powell.

Trump’s condemnation of Powell obscures the fact that most central banks have tilted toward easing because economic circumstances, risks to growth and benign inflation warrant it. Trump will get his cut, economists predict, as soon as July.

But rate reductions are on the menu around the world for much the same reasons; when it comes to monetary policy, differences are largely matters of degree, not kind. That’s not to say that weaker exchange rates don’t have their benefits, or aren’t a by-product of rate cuts.

But it’s important to understand that currency management is rarely, if ever, the sole motivation.

Exchange rates are an “important channel” through which easing stimulates growth, Reserve Bank of Australia Governor Philip Lowe said. “But if everyone is easing, there is no exchange-rate channel. We trade with one another, we don’t trade with Mars, so if everyone’s easing, the effect that we get from exchange rate depreciation via the transmission mechanism isn’t there.’’

As far-fetched it may seem, all of Trump’s talk about currency manipulation has serious people considering the prospect that the US could directly and unilaterally sell dollars in the market, a practice mothballed years ago. Direct interventions only tend to work when allies cooperate to achieve common aims.

In 2000, the world’s major central banks bought euros to boost the common currency, which was floundering in its infant stage. A similar team intervened to stem the yen’s surge after Japan’s 2011 tsunami, and its slide during a banking crisis in 1998. Each was broadly successful. In the modern era, interventions have also helped emerging markets stabilise their currencies, Bank of America noted in a report. It’s hard to conceive Europe or Japan going along with a Trump tantrum that serves no goal other than making the dollar cheaper against the euro, yen or British pound. If Trump’s target is China, the rest of the G-7 have zero interest in being seen to gang up against Beijing. Solo maneuvers don’t stand much of a chance of fundamentally altering a currency’s trajectory — or defying monetary-policy logic. Trump would do well to bear all this in mind. There’s no commerce on Mars.