CURRENCY WARPossible Emergence of new currency

Presented By:

Nadeem Khan

Namrata Kumari

Manish Singh

Mateen Ahmed

Meghna

Mohit Thaparia

Manjari Manisha

• ‘Currency wars’ :The manipulation of currencies to boost exports.• Currency war, also known as competitive devaluation, is a condition

in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency.

• “Currency war” - term first introduced by Guido Mantega, the finance minister of Brazil.

• A lower value for the home currency will raise the price for imports while making exports cheaper.

• It significantly increase risks for cross-border trade and investment

Currency war in global economy:

• ‘Currency wars’ (the manipulation of currencies) have been associated with downturns in the global economy as governments attempt to boost their ailing economies through export growth.

• Such manipulations require that currencies are kept weak in order to make exports competitive on the global stage.

• The risks associated with currency war is, uncertainty over government policy, currency volatility and supply chain disruption.

Reasons for currency wars:

• Trade disputes between countries: Disputes in this context arise over trade ‘dumping’ (flooding a domestic market with goods or services to force domestic producers out of the market to give the exporting country a monopoly) and countervailing duties ( Ex: Country A imposing increased tariffs on goods from Country B if it believes Country B is subsiding its exports).

Contd…

• Currency Volatility: The sharpest volatility was in countries that were highly reliant on commodity exports: this was primarily down to the significant shifts in global commodity prices .

• Trade Protectionism: National policies could offset global attempts to encourage trade.

• Global financial institutions such as the IMF, World Bank and WTO are attempting to encourage trade.

• The first currency war started in the 1930s during the Great Depression when countries dropped the gold standard, which resulted in a loss of intrinsic value and therefore devaluation of the currencies as nothing backed the paper money in circulation. 

• When one country devalues its currency it gains a short term advantage until the neighboring countries follow suit. 

• Once competing countries have devalued there is no more advantage and the price to pay is that international trade suffers, which in the end impacts all countries negatively.

• The currency wars of the 1930s ended with the Tripartite Agreement in September 1936, countries agreed to sell gold to each other in the seller’s currencies at an agreed fixed price, which helped to stabilize exchange rates .

•  During the years until 1971 under the Bretton Woods agreement, countries did not have the option to engage in currency wars; even after the gold standard was abolished countries had little incentive to engage in competitive devaluation since no synchronized effort among nations existed.

• The recent financial meltdown of 2008 caused the re-emergence of currency wars as countries look for ways to improve their financial positions by reducing large current account deficits. 

•  Developed countries chose export strategies through competitive devaluation. 

• Reported in March 2012, Japan’s current account and trade deficit hit a record high in January, even though a weak Yen has been seen as “growth hormone” for the export driven economy, it is now backfiring due to Japan’s reliance on importing fuel for energy production since the Fukushima accident a year ago . 

• Even Australia, which has been doing very well due to continued exports of coal and iron to China, recorded its first trade deficit in eleven month in January and an 8% drop in exports, the largest drop in the past three years. 

• The Australian dollar had appreciated 4% against the US dollar this year so far . 

•  Brazil reported a current account deficit of $7.1 billion in January 2012, the largest deficit on record and the real has appreciated 9.3% against the US dollar this year, more than any other currency .

 since June 2011 China has been selling US Treasuries from a high of $1.315 trillion in July 2011 to $1.152 trillion by the end of

December 2011, a reduction of $163 billion.

 “China, the world’s second-largest crude consumer, finished filling the first phase of its emergency stockpile with 103.2 million barrels of oil in 2009. The second phase, comprising eight locations with a

storage capacity of 168.6 million barrels, is scheduled to be completed by early 2013. The Lanzhou depot has a capacity of 18.9

million barrels”. 

Brazil launches fresh ‘currency war’ offensive

• Brazil will no longer “play the fool” and let its currency appreciate while richer nations gain economic advantage by devaluing theirs, its finance minister Guido Mantega, said this week.

• On the contrary, Brazil has embarked on a new offensive to suppress gains in the real. On Monday it extended a tax on foreign loans for the second time this month.

Currency Wars chronology

• 1947(when India became member of IMF): rupee tied to pound.• 18 sept,1949: pound devalued; india maintained par with pound• 6 june, 1966: rupee devalued, Rs 4.76=1$, after devaluation, Rs

7.50=1$• 1971-1979: rupee is overvalued due to india’s policy of import

substitution.

Contd…

• 23 June, 1972: UK floats pound, india maintains fixed exchange rate with pound.

• 1975: india links rupee with basket of currencies of major trading partners. Although the basket is periodically altered, the link is maintained until the 1991 devaluation.

• July 1991: rupee devalued by 18-19%• March 1993: inified exchange rate:1$=31.37• 1993/1994: rupee is made freely convertible for trading, but not for

investment purpose.

Need for devaluation• Overvaluation of currency associated with import substitution

for industrialization as opposed to export promotion policies.• The risk of losing competitiveness.• To relieve an unfavorable balance of trade.• Economic stabilization.• Correcting the price distortions.• To increase competitiveness in foreign market.• To raise national income per capita• Close the development gap.• Restriction on commodity as well as capital flows.

The effect of devaluation• Improve trade balance• Alleviate balance of payment difficulties.• Accordingly expand output and employment.

• Each currency linked by a rate of exchange to each of the other currencies in the world

• We may also compute the “average” rate of a currency with the currencies of trading partners. This is the effective exchange rate.

• A currency is also an asset, a way to store wealth. The value of a currency tomorrow is not the same as the value of that currency tomorrow set as of today

• The spot rate between two currencies is not the same as their forward rate.

• And the rate at which two currencies are exchanged is not the same as the exchange rate that measures the purchasing power of a given currency in terms of goods in the domestic country and in a foreign country

In a world without uncertainty, investors face two exchange rates:

>Spot market: price for immediate delivery of one currency for another>Forward market: exchange rate fixed today for future delivery of currency

• External trade balance = exports – imports• With trade balance<0, demand for foreign currency

(necessary to import) higher than supply (obtained from exporting).

• Result: exchange rate depreciates and, doing so, makes exports less expensive and imports more expensive

• The introduction of the Euro was defined as “the most important development in the evolution of the international monetary system.

• The euro is the second largest reserve currency as well as the second most traded currency in the world after the United States dollar.

• It is the second-most traded currency on the forex market, as many institutions and individuals trade the EUR.

• Many experts considered the Euro a possible rival for the Dollar and a threat for its predominance as an international currency.

• The reasons why the introduction of the Euro :• The USA has been and is still being affected by international debt and deficit

problems, which turned the USA from the world biggest creditor to the world’s biggest debtor.

• In 2003 the US current account deficit reached $550 billion, or about 5 percent of GDP”.

• US and Europe are finding economic growth difficult to achieve because of a lack of domestic demand: consumers and businesses are not spending, choosing instead to reduce their debt levels and/or increase their savings.

• One way in which governments can attempt to drive economic growth is by adopting policies that increase their country’s exports. Politicians have a number of options for doing this, but a favoured choice is to depreciate the local currency, so that a country’s goods/services become relatively cheaper on the global stage.

• A weak currency also increases the cost of imports, thus making domestic producers more competitive in the national economy, again driving growth. However, there are problems with maintaining a consistently under-valued currency, not least of which is that it encourages inflation, which is itself detrimental to driving growth.

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