China’s decision last week to devalue its currency threatens to ignite a full-scale currency war that could cause massive financial problems to a global economy that looked to be finally throwing off the ill effects of the 2007-2008 global financial crisis.
China is by no means alone in its actions. The United States Federal Reserve and the European Central Bank both engaged in aggressive policies aimed at weakening their currencies, with the US just last year ending its stimulus for the dollar. Ironically, it was China’s previously strong economy and growing consumption that kept global growth on a manageable level at a time the US and Europe were desperate to boost exports. China’s move was in no way unexpected either. Economic growth has been flagging since last year, and last week’s announcement that exports had dropped 8 per cent was the final straw. However, the real issue surrounding a devalued yuan is not whether China now has an economic advantage over other currencies or whether countries like South Korea and Indonesia will make their own competitive devaluations. It does, and they will. The issue is the tsunami of deflation that is about to hit the global economy. Consumers will, of course, see no reason to complain about lower prices, but companies will now be faced with quarter after quarter of diminishing revenues, which could lead to higher redundancies and a weaker overall economy. This a particular concern for GCC countries, which are already facing major economic pressures from falling oil prices.
Opec’s ongoing policy to fight for market share will only push the US dollar higher, in effect further fuelling the currency war. It is a downward spiral that only a concerted effort from the international community will solve. This a problem the world has previously solved. In the 1930s, the implementation of a system of fixed exchange rates stopped a global deflationary threat. This system fell apart in the 1960s in the face of global economic growth, but it served its original purpose. The question today isn’t whether such systems would work, but whether any sovereign nation has the political will to put the global economy ahead of its own.
