The Currency Conundrum

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Different currencies in the World.
One of the downside of globalization that any profit opportunity available to the investors would be pounced upon until it disappears. Tackling the Japanese deflation situation is fueling debate over the currency issue, and will dominate at a time when monetary policies are at the forefront of every country’s agenda. Photo-IoM/Flickr/CC

The recent G-7 summit and announcement has put forward a new question in the economic world and it seems to be one that has been recurring throughout the history of international trade and finance. Is there another currency war underway? Every economy in the world wants to first of all look after its own people in context of employment, inflation and economic progress and then sees how it can carry forward that economic and competitive advantage into the international sphere. The problem begins in the double edge sword which sees that as international linkages are beneficial to a country’s economy, they can also be a curse.

The economic imbalances within a country signal towards the economic policies that would be followed by them and gives the outside investors to take advantage of this situation. The case of Latin America in the 80s and Asian in the 90s is a clear example of that. Due to higher returns and lower interest rates, many investors flooded the market with their capital flow and investment. The emerging economies of Thailand, Singapore, Malaysia, Hong Kong and other Asian tigers were growing steadily and were giving out returns that were far greater than their Western counterparts.

Due to the rise in the demand for their currency, a bubble was formed in the currency and when the bubble reversed, all the countries suffered heavily from the consequences. It took them years to claw back the ground they had lost in the wake of the Asian currency crisis.

An opposite situation took place in Japan where interest rates were nearly zero and people kept borrowing at near 0 percent and investing it in other regions in order to gain a return. The reverse of this proved detrimental for Japan as the subsequent appreciation in the currency led to a huge fall in its exports. It seems now a similar situation is taking place. All the countries want to protect their own economic interests and with fear of Euro in the recent months and the bet against it by the hedge funds shows that people will use the economic information to take advantage in any shape possible.

It is one of the downside of globalization that any profit opportunity available to the investors would be pounced upon until it disappears. The situation now stands on the precipice. First of all, the grievance of the world over the manipulation of China over its own currency in order to keep it cheap, making its exports cheap and competitive in the international market. The Japanese deflation situation where the central bank wants to do all in their power to stimulate the economy by cutting interests and injecting liquidity in the market.

This will depreciate their currency which is not in a favourable manner by the other countries. This lead to a rise in the value of yen as other countries is also trying to do the same in order to grow their economy in any way possible. In this situation, the G-7 has provided some support to the policy initiative by Japan by saying that it supports Japanese motives to address the problem of deflation and that there was no rationale for a currency war.

This might be true but the flooding of the markets with fresh liquidity by Japan, US and UK puts the emerging currencies at a disadvantage and they might be forced to also take steps to depreciate their own currencies. There is still doubt in the market about whether the steps taken by these countries is the right way forward and it would be clearer when the G-20 leaders meet to get a clearer picture of the roadmap forward and how the policies should be shaped in the coming period. At this point it seems that the debate over the currency issue will dominate at a time when monetary policies are at the forefront of every country’s agenda.

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