Global Economy Currency War

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TABLE OF CONTENT

Content Page

1 Cover Page 1

2 Table of Content 2

3 1.0 Introduction

1.1 Competitive Devaluation

1.2 Significance of Competitive Devaluation

1.3 Structure of Report

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4 2.0 International Currency Wars

2.1 United States of America

2.1.1 Introduction

2.1.2 Describing the US Dollar Against Euro

2.1.3 Key Factors Influencing Value

2.1.4 Negative and Positive of Dollar Appreciation and

bbbbbbbbbbbbbbbDepreciation

2.1.5 Conclusion

2.2 Republic of China

2.2.1 Introduction

2.2.2 Chinese Currency Fluctuation

2.2.3 Factors Resulting In the Peg of Chinese Currency

2.2.4 RMB Appreciation and Its Effects on Chinese

vccccccccccccccccEconomy and Business

2.2.5 Conclusion

2.3 Japan

2.3.1 Introduction and The Currency Path

2.3.2 Factors Contributing to The Changing value of the

gggggggggggggggCurrency

2.3.3 Relative Merits of Appreciation and Government

hhhhhhhhhhhhhhhIntervention

2.3.4 Conclusion

2.4 United Kingdom

2.4.1 Introduction

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2.4.2 GBP Sterling Against the US Dollar Analysis

2.4.3 Factors Which Have Changed the Value of the

vvvvvvvvvvvvvvvGDP Sterling against the US Dollar in Relation to

vvvvvvvvvvvvvvvTheories

2.4.4 Implications of Currency Appreciation and

ffffffffffffffffffffDepreciation

2.4.5 Conclusion

2.5 Malaysia

2.5.1 Introduction

2.5.2 Path of The MYR in The Past 12 Months

2.5.3 Key Factors That Contributed Towards Fluctuation

2.5.4 Advantages of MYR Appreciation

2.5.5 Conclusion

2.6 Germany

2.6.1 Introduction

2.6.2 EUR/USD Exchange Rate Analysis

2.6.3 Conclusion

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5 3.0 Conclusion 38

6 References 39


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1.0 Introduction

1.1 Competitive Devaluation

Competitive devaluation is also known as currency wars where nations across

the world struggle to depreciate their own currency to help their domestic market.

According to Xinhua (2010), this is the situation where a country depends on its own

economic power to best its competitors and take hold on other nations affluences

through monetary and foreign exchange policies. Such policy was for a specific

purpose and usually with sizeable destructive power but nowadays such war was

much friendlier.

1.2 Significance of Competitive Devaluation

One of its importances is because of its capability of reducing trade deficit.

When a currency is devalued, exports can be stimulated and as a result it will not just

increase the countries income but it will also increase employment within the country

(Xinhua, 2010). This is because more exports will lead to more productivity which

requires more labour. Whether or not to adopt such policy must be made after due

consideration because of its danger in the long run. The interest conflict between

countries will become even worse which eventually did not solve the problem due to

more and more countries adopt such policy.

Besides that, competitive devaluation will guarantee inflation. Although

inflation is generally seen as an unpleasant moment but in some cases it helps protect

the wealth of certain groups of people. In terms of gold, it helps ensuring gold price to

keep rising and thereby protect the gold investors prosperity. (Adask, 2010)

Furthermore, devaluation can help solving the product-surpluses problem. This is

justified by Xinhua (2010) who mentioned about increase exports when currency

devalued.

Other than that, competitive devaluation or depreciation in currency can help

easing a governments burden to hold more foreign exchange reserve. These reserves

are particularly useful in the future for protecting their own currency. This applies to

countries that have a fixed exchange rate. It is also important for floating exchange

rate during a period where the fluctuation is intense enough to cause havoc to theglobal economy. (Wifle, 2008)


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1.3 Structure of Report

This report comes with a simple format which divides into three parts:

introduction, body and conclusion. The body was further divided into six sections

resembling six different countries: USA, China, Japan, UK, Malaysia and Germany.

These six sections includes the currency path for the past twelve months from the six

countries, key factors that contributed towards the fluctuation of the exchange rate and

merits of currency change as impacts to those countries.

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2.0 International Currency Wars

2.1 United States Dollar (USD) Against Euro (EUR)

2.1.1 Introduction

The U.S. dollar occupies the basic monetary unit between different countries

all over the world, as well as, it belongs to the official currency of the America. In this

report, different factors affect the value of dollar, which include balance of payment,

interest rate of America, economic index, and inflation. Moreover, summarizing these

factors, to analyze positive and negative for appreciation & depreciation of the U.S.

dollar, which combing with activities of governments and local businesses in

America.

2.1.2 Describing the US Dollar Against Euro

There is a curve chart as figure 1-1 to shows the U.S. dollar against the Euro

between October 30, 2009 and October 29, 2010, the general tendency rise by

+0.0531 (7.97%) during the last one year.

Figure 2.1.1: The Exchange Rate of the U.S. Dollar Against the Euro

The Exchange Rate of the U.S. Dollar Against the Euro , (google.com, 2010)


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Depend on the curve chart to know that the value of dollar belonged to quite

low value before 2010, while there was sharp growth up to 0.8386 on June 8 th, 2010.

However, it fell back until August 6th, 2010 to 0.7532, but it was much higher than the

value of currency before 2010. After a brief rally value of dollar fell back to a now

low until October 14th, 2010 that the value of the U.S. dollar fluctuated between 0.700

and 0.725 in the last one months.

2.1.3 Key Factors Influencing the Value

Now, explaining relative influencing factors of economy situation of America

via vary of exchange rate for dollar. China as an important trading partner for

America, due to trade could create more jobs opportunities for areas of the Pacific,

and improve the life quality for residents. Trade boost local economic development,

on the other hand, trade gaps lead to huge US trade deficit. From the figure 1-2 to

know, with increasing export to China since 1999, a growth trade of imports that

widen differences in trade deficit until now.

Figure 2.1.2: U.S. Monthly Trade Balance with China between 1990 and 2010

U.S. Monthly Trade Balance with China, (money.cnn.com, 2009)

The export amount was less than import amount thus lead to America trade

deficit. Making exports less competition within foreign market, as well as, increasing

the quantity of import goods from other nations. Therefore, the payment of currency is

much more than income in America, that leads to the U.S. dollar decrease value.


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According to Krugman (2003), interest rates play as important role within the

foreign exchange market due to the large deposits traded should pay interest. Banks of

different nations use interest rate to adjust and control capital flow. Comparing

interest rate between European Monetary Union and United States as figure 1-3,

current interest rate of European Monetary Union (1.00%) is higher than that of

America (0.25%).

Figure 2.1.3: Europe and North America Interest Rates Table

Europe and North America Interest Rates Table,(fxstreet.com, 2010)

As investors, in order to avoid the risk of interest rate, transfer currency from

low interest rate to high interest rate in other nation, in order to obtain more benefits

by high interest rate. While, central bank of nation adjust interest rate to control

balance of investment yield for economy of local. Policy, quantitative easing, could

push interest rates down, prompting investors to run away from the dollar and flock to

higher-yielding assets.(CNNMoney.com, 2010) The U.S. dollar drop against others

international currencies, which include the Euro, the Japanese Yen and China Yuan,

due to capital outflow of the U.S. dollar.

With increasing the quantity of import goods from others areas, that also affect

the amount of currency in local. Interest rate as modified by inflation, interest rate of

America belongs to low level (0.25%). Depend on the lower interest of America to

analyze inflation affect exchange rate, consumers will pay more money to purchase


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goods and services without saving in bank, as well as, lead to more money in

circulation in social. Therefore, leading to the price of goods and services growth, and

purchasing power weaken.

Figure 2.1.4: Over-The-Year Percent Change in CPI-U

Over-The-Year Percent Change in CPI-U, (http://www.bls.gov, 2010)

Via searching related data of Consumer Price Index on October 15, 2010, this

was increasing consumer level as a whole. Over the last 12 months, the food index

rose 0.6%. The energy index rose 1.1% over the last year, with gasoline and natural

gas rose at a faster pace, up 6.4% and 7.7%. However, the index for all items less food

and energy rose 1.2 % in August and September 2010. (CNNMoney.com, 2010) As

this situation, belongs to inflation, devaluation was result from increase the price of

goods and services in America.

2.1.4 Negative & Positive of Dollar Appreciation and Depreciation

To increase the value of the U.S. dollar that improving inflation situation in

America, pressing the price of goods and services via governments control.

Especially, investors would like to buy securities to earn more benefits, which are

increasing the purchasing power parities. However, there are negatives for dollar

appreciation. The export of America and local businesses both face risks of trade,


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such as supply exceeds demand thus possible leading to supply surplus that could

drive down prices.

Figure 2.1.5: The Trend of Percentage of Unemployment During 2009

The Trend of Percentage of Unemployment During 2009, (gallup.com, 2009)

On the other hand, depreciating the U.S. dollar that America direct affect the

price of goods become lower in America, thus enhance related businesses

competition in the international market. That good for stimulation export thus push

the economy of America resurgence and avoid deflation. However, increasing the

unemployed rate becomes an important problem in America, figure 1-5 shows current

decline below 50%. Government spending becomes less to resolve the problems of

America and affect directly relevant welfare for employees.

2.1.5 Conclusion

In conclusion, the U.S. dollar moderate depreciation is advantage for the

economic development of overall world. Government intervention of America as an

important tool to adjust the demand and supply for U.S. dollars via change exchange

rate, that governing with development of local businesses economy. In order to

control balance of trade between export and import via trade barrier, as well as, also

influence activities of businesses to improve their competitive competence and

benefits via changing dollar. Exchange rate are affected via vary of economic index,

which includes the prices of goods and services, unemployment rate and credit

availability during consumers activities in America.

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2.2 China Yuan Renminbi (CNY) Against United States Dollar (USD)

2.2.1 Introduction

For around last 15 years the Chinese government has intervened in currency

markets to control the appreciation of Renminbi (RMB : meaning peoples own in

Chinese). The regulation aims to attract FDI and keep its industrial products cheap

internationally thus a major reason for its economic growth (Tung and Baker, 2004).

Opponents of the regulation term the measures as a manipulation to ensure cheap

exports and expansive imports into China. (Frankel, 2006)

Based on strong pressure from other nations China has allowed gradual

appreciation against world currencies however the global recession and economiccrisis again forced the Chinese regulators to follow a controlled rate . This slow rate

of appreciation is also criticized by world economists terming the RMB appreciation

an important factor to rebalance the world economy while citing meeting local

consumer demands and increasing imports into China as key benefits to China.

(Zhang and Pan, 2004)

This paper revisits the history of RMB fluctuations to study the factors

resulting in its relative peg against dollar and aims to shortlist the merits to Chinese

economy if it is allowed to float freely.

2.2.2 Chinese Currency Fluctuations

Before 1994 China maintained a two layered exchange system where fixed

interest rates and swap market rates for imports and imports co existed. The two rates

were joined in 1994 at 8.70 to the dollar and revised to 8.28 in 1997 the rates then

remained constant till 2005. (Brahm and Li, 1996:127, Lu, 1994) In July 2005 the

rates were half floated based on market supply and demand , resulting at a rate of

8.11 Yuan (Joseph Stiglitz ,2005) ; 2.1% appreciation. This pegging was not truly

floating with maximum movement of 0.3 % allowed. Thus RMB slowly rose and

reached 6.83 to dollar in July, 2008 (20.8 % appreciation ) . The summary of data is

reflected in Figure 2.2.1.


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Recent RMB Developments:

ON 22nd of June this year RMB was devalued 1.43% to 6.80 to a dollar.

Threatened by further sanctions and legislations, till October 1st, the RMB has been

further cut by 1.9%. Refer to Figure 2.2.3 below.

Figure 2.2.3:

2.2.3 Factors Resulting In the Peg of Chinese Currency

The currency control of the RMB has been found to be somewhat different

from conventional floating exchange rate theories since the Chinese government has

been directly involved in the control of RMB. Various factors resulting in this control

from the Chinese prospective have been discussed as of below.

One of the first argument provided by the Chinese is regarding the peg is the

fact that is being used to ensure stabilization of internal economy through growth

rather than aim of increased exports. However it is quite clear that the policy reflects

the government desire to attract FDI to gain technology , know-how and to increase

growth. (Jensen ,2006) The Chinese defend the gradual appreciation in currency by

stating the fact that the dynamics of a nation where 40 million people still live lessthan a dollar a day cannot be compared to a developed economy . (Fernald et all 1999)


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2.2.4 RMB Appreciation and Its Effects on Chinese Economy and Business

It is quite clear that an under quoted RMB will increase FDI , give boost to

countrys exports however such policy can have following long term demerits for the

country

Demerits of Currency Regulation

Such protection measures can result in a country depending more and more on

its exports thus always exposed to global conditions. Furthermore an undervalued

currency will result that all the imports coming to China in terms of machinery and

tools etc are being bought are expansive. From the prospective of an international

buyer, instead of giving benefits to own country China is in fact giving subsidy toother nations by keeping its currency depreciated. By using the pegged system, the

Chinese government losses its ability to control monetary policy, thus resulting in

internal inflation and easy credit policies by the banks which has resulted in over

saturated real estate sector.

Merits of a Currency Appreciation through deregulation

Even if we agree that some adjustment costs would be there the merits of thesuch a move include the rapid boost to Chinese trade by a increase in its imports on

the money received from exports, It allows a greater flexibility to Chinese government

by channeling money to ineffective to effective sectors. It helps in lowering prices of

imports thus providing better quality of life to consumers. It will increase the domain

of government to influence its monetary policies furthermore it will also help in

resolving income and growth disparities between different regions. Last but not the

least such a move will develop the trust that is very important between China and its

trading partners all over the globe.

2.2.5 Conclusion

There is no doubt that the Chinese economy due to its relative size ,

unsaturated nature and growth potential will continue to lead the global growth and

development in the years to come. However in the age of globalization it becomes

very difficult for a nation to take economic decisions independently. The situation is

further compounded by the fact that global recession is directly affecting Chinas


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growth. Through the analysis carried out in the paper we have come to know that the

only way forward for China is through currency appreciation. For the government it

provides such important benefits as ease of regulations , control of inflation , focused

development of sectors, removal of wealth disparity and improvement of quality of

life , while for the businesses it means cheaper imports, and sustained growth .

Therefore deregulation of RMB by the Chinese government should be the policy

decision.

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2.3 Japan Yen (JPY) Against United States Dollar (USD)

2.3.1 Introduction and The Currency Path

The economy of Japan is one of the most vibrant and booming economy in the

world. High amount of western influence together with the government policy of

Laisser-faire was mostly responsible for the significant growth in the economy of

Japan in the post second world war period. This report will be looking at the current

issue of competitive devaluation and its economic and business implications.

Figure 2.3.1 (Bank of Japan Foreign Exchange Rate)

October 2009

90.28

November 2009 89.11

December 2009 89.52

January 2010 91.26

February 2010 90.28

March 2010 90.56

April 2010 93.43

May 2010 91.79
http://images.google.co.uk/imgres?imgurl=http://www.uni.edu/becker/japan1.gif&imgrefurl=http://www.uni.edu/becker/japanese.html&usg=__93c9gBoy2cVE7Tb3QipfGVT142s=&h=367&w=323&sz=9&hl=en&start=2&um=1&itbs=1&tbnid=cW5i6Y7oxtxasM:&tbnh=122&tbnw=107&prev=/images?q=japan&um=1&hl=en&sa=N&tbs=isch:1


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According to Bloomberg, Yen drops on concern Japan may weaken currency,

(by Paul DobsonOct 26, 2010). The yen slid from its strongest level in 15 years

against the dollar amid concern Japanese authorities may renew action to weaken the

currency. The yen slid 0.7 percent to 81.40 against the dollar at 8:28a.m in New

York, from 80.81 yen yesterday, when it reached 80.41 yen, the strongest level since

April 1995.

Japans currency has appreciated more than 5 percent against dollar since

authorities intervened in foreignexchange markets for the first time in six years on

September 15.

2.3.2 Factors Contributing to The Changing value of the Currency

Industrial Production:

The IP Index, measuring trends in the output of Japanese manufacturing,

mining and utilities, is extremely important for gauging the state of the economy. The

outlook for production is highly dependent on the strength of Japanese exports.

However, an impending yuan revaluation is a key issue because this will tend to

increase Japan's ability to export to China and also boost the competitive standing of

Japanese products on other countries' store shelves.

Foreign Trade:

Import and export figures measure the value of goods shipped into and out of

Japan. Exports figures are usually closely followed, along with imports figures, which

indicate the strength of domestic demand. Although China has been the chief

contributors to Japanese export growth in recent years, the U.S. economy is regaining

sway in becoming the most important market for Japanese companies. Forecasts

indicate that the re-emergence of the U.S. is a very good thing for Japan. However,the U.S. will take time to have as dynamic an effect in Japanese sales as China has

June 2010 90.89

July 2010 87.67

August 2010 85.44

September 2010 84.31


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had in the past. Predictions are that double digit export growth figures are unlikely

until China develops a renewed taste for Japanese wares.

Inflation Rate:

Inflation is the result of rising prices in an economy over time. In other words,

when the inflation rate is positive, a currency buys fewer goods than it did in the

previously. Japan has had one of the lowest inflation rates since the mid 1990s. In

fact, price levels in Japan decreased between 1998 and 2004. The low inflation rate

has kept Japanese products cheap compared to products from other countries, making

Japanese industries more competitive. This has added to Japan's export growth and, in

turn, increased demand for the Yen. The inflation rate is also dependent on the value

of the Yen since a weaker currency leads to greater demand for Japanese products and

makes imports more expensive for Japan, hence increasing the inflation rate. The

inflation rate in Japan was last reported at -0.6 percent in September of 2010. From

1971 until 2010, the average inflation rate in Japan was 2.97 percent reaching an

historical high of 24.90 percent in February of 1974 and a record low of -2.50 percent

in October of 2009.

Interest Rates:

Since the late 1980s, the Bank of Japan has been driving the interest rate to

very low levels in order to spur economic growth. Short-term lending rates have

responded to this monetary relaxation and fell from 3.7% to 1.3% between 1993 and

2008. This made it profitable to borrow money in Japan in order to fund investments

in other countries. This activity, better known as yen carry trade, bears the risk of

being losing bets when the Japanese Yen appreciates against other currencies. Carry

trades have been a key determinant of the value of yen relative to other currencies.

Based on short Yen futures positions, which are used to hedge against the risk of Yen

appreciating, the total amount of Japanese Yen used in carry trades is estimated to be

around 125 trillion ($1.2 trillion).

Historically, carry trades have helped to keep the value of Yen low compared

to the US dollar and other major currencies. However, they also make the Japanese

Yen extremely sensitive to financial crises across the globe. During the Russian

financial crisis in 1998, the Yen gained 20% in two months. After the US sub prim


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Crisis the Yen rose from 124/dollar in June 2007 to 94/dollar in October 2008. The

amount of carry-trades is dependent on Japan maintaining a low interest rate relative

to other countries. In 2008, both the Federal Reserve and European Central Bank

aggressively drove down interest rates in the US and the European Union.

2.3.3 Relative Merits of Appreciation and Government Intervention

Recent continuous appreciation of the yen, the Japanese Government is

worried that the deteriorating situation in exports, the yen worries increased. Japanese

government officials began as verbal intervention, the morning of August 25, said

Naoto Kan, Japanese Prime Minister will announce the economic policy response to a

stronger yen. On the same day, Japanese Chief Cabinet Secretary Paradise Valley by

the wild Tianjia Yan and the Japanese Finance Minister were also stressed the need to

intervene in the foreign exchange market. Japanese Government officials continue to

release signals to the market, hoping to stop the yen continued upward.

Nevertheless, the yen appreciation would still go its own way. Bank of Japan

further expansionary macroeconomic policies to soften the yen stimulate the

economy. Japanese government originally planned launch in September a new round

of economic stimulus plan announced in advance. 30 August 2010 the Japanesegovernment announced plans to use the reserve fund in the annual budget of 920

billion yen, to implement new economic stimulus plan. At the same time the Bank of

Japan held an emergency meeting in the day decided to expand its supply of tools for

financing the scale of its fixed rate funding for the supply of bank operations to

expand in size from 20 trillion yen to 30 trillion yen, but the introduction of these

measures have not been able to suppress the yen continued to appreciate the

momentum.

As Japans slow economic recovery, the yen continued to appreciate further,

exacerbated by the Japanese government concerns about the economic recovery. 15th

session in Asia, Japanese Finance Ministry official intervention the yen, to prevent

excessive appreciation of the yen, the dollar surged against the yen instant hundred

points, the Japanese yen against the U.S. dollar also from September 14 to rise to 9

83.02901 January 15 85.75128, appreciated by 3.28% appreciation of the yen eased

the pressure temporarily.


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2.3.4 Conclusion

Appreciation of the yen, Japanese exports less competitive, affecting the

domestic trade sector. Japan is export-oriented countries, in order to stimulate the

economy, the first time in 6 years the Japanese government intervention in the foreign

exchange market directly to suppress the yen appreciation.

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2.4 Great Britain Pound (GBP) Against Unites States Dollar (USD)

2.4.1 Introduction

An investigation in to the prevailing issue of competitive devaluation between

the predominant currencies the Sterling, measured against the Dollar. The report will

firstly describe the Sterlings path against the Dollar for the past twelve months. Then

the report will analyse the key factors that impact the Sterling, with the use of

academic theory. Furthermore the report will then look at the implications of currency

appreciation and depreciation. Lastly it will conclude by summarising the key points

in the report.

After the Second World War; money now flows freely in a global capitalmarket economy. (FT, 2010) The price at which two currencies are in exchange, is

known as the exchange rate. Moreover exchange rates between two currencies are

known as nominal exchange rates and the real effective exchange rate. It takes in to

account the inflation rate differentials and enables the ability to calculate the degree of

which the currency is valued and undervalued over time. (Begg et al, 2003)

2.4.2 GBP Sterling Against the US Dollar Analysis

Figure 2.4.1:


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UK Pound Sterling vs US Dollar Forex Chart, (Forex, 2010)

Figure 2.4.1, highlights that in the past year the Sterling against the US Dollar

has in recent months been depreciating. There is a downward trend of the Sterling

measured against the US Dollar.

Figure 2.4.2: Percentage Change of the Sterling Against the Dollar

Percentage Change of the Sterling Against the Dollar, (Currency Chart, 2010)

% Change


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The overall trend is steady although there has been a quarterly decrease in the

value of the Pound against the Dollar in the last quarter. The Sterling against the

Dollar has been on a steady decreasing slope downwards. The percentage change on

average is negative thus conveying currency depreciation.

2.4.3 Factors which have changed the value of the GDP Sterling against the US

Dollar in relation to theories

Firstly the changes in demand and supply change the currency value, for

example when demand exceeds supply of currency then the currency is more valuable

vice versa.

Secondly UK consumers may prefer to save, in order to increase wealth, thusthis will change the Sterlings value. Also it is evident that there is a problem of

unemployment in the UK (The Economist, 2010), therefore this will mean that the

value of the currency decreases and GDP goes down. Moreover the interest rate is low

in the UK at present thus the demand for currency is falling and due to an increase in

speculative demand for Sterling. (Bank of England, 2010)

In continuation for both the UK and the U.S.A exchange rates are free floating,

meaning that the laws of supply and demand determine the foreign exchange market.

In this analysis e denotes the exchange rate, which is measured in Dollars per pound.

e=/$ (1)

Here the exchange rate is the inverse of the pound per Dollar. So when the

exchange rate depreciates this means e rises, thus meaning that the relative price of

imports grow and domestic goods are less expensive. Therefore meaning that exports

from the UK are worth less and imports are more expensive from the U.S.A. This

depreciation leads to an increase in net exports as demand arises for domestic goods

(exports) x. (Blanchard et al, 1997)

X(e)=K+Ke (2)

Furthermore there are many economic theories in relation to the exchange rate.

The purchasing power theory puts forward that the exchange rate is determined by the

difference in price level between the countries, in order to maintain constant terms oftrade. Therefore the absolute purchasing power parity is,


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e=p/p* (3)

This implies that when p* or p change, then e differs to maintain a fixed

value1. Meaning that a product selling for p* in the U.S.A will sell for ep* in the UK.

Therefore if ep*>p then no one will purchase the US goods. Although if ep*

0) which

means a Sterling depreciation is due to the rise in domestic prices to those in the

U.S.A. (Lopez et al,2007) In continuation (Fisher,1930, in Hatemi, 2009) highlights

the relationship between the purchasing power of money and the nominal interest rate,

measured by the inflation rate. The response of the nominal interest rate to the

inflation rate is the Fisher effect. In addition Fisher(1930) argues that the real interest

rate is not affected by the changes in the anticipated inflation rate as this is projected

in the nominal interest rate.If the real interest rate is held steady then the nominal

interest rate responds in line with the inflation rate according to the Fisher effect.

Therefore the international Fisher effect theory portrays that the interest rate

differentials between the UK and the U.S.A should be in align with their expected

inflation rate, which then adjusts the exchange rate.

Another theory is the interest rate parity theory of exchange rates. This

highlights that exchange rates change due to changes in the interest rate in the short

run. Therefore this theory highlights that the interest rate is an important factor which

affects the exchange rate. (Baum and Chakraborty, 2010)

2.4.4 Implications of Currency Appreciation And Depreciation

Britain devalued the pound in 1967 because of the tremendous deficits on the

balance of payments due to ineffective government policies. This meant that the

Sterling was cheaper to buy, hence exports lower in price, this way the demand for

exports increased and imports decreased improving the trade balance. (The

1R=ep*/p, R=1 and e is equal to e=p/p*.


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Economist, 2010) The exchange rate changes in diagram 1 and this affects the

international competitiveness of a country, in this case the UK.

Figure 2.4.3:The Floating Exchange Rate Regime: The Case of Currency

Depreciation

Here we assume that the Sterling and the Dollar are traded on the FOREX

market, here the domestic interest rate falls relative to the interest rate on the Dollar.

This then leads to a fall in demand for Sterling, moving from D1 to D2, thus causing

an outflow of capital to the U.S. Therefore the investors convert their assets in to the

Dollar, thus the supply of Sterling increases hence supply moves from S1 to S2

resulting in depreciation. So meaning exports are more competitive and imports more

expensive.

In addition currency depreciation may lead to macroeconomic uncertainty and

domestic producers may pass on costs to consumers due to higher raw material prices.

Which can lead to cost push inflation, thus a wage spiral occurs and real incomes fall.

Also there may be loss of production and output meaning the economy is allocatively

and productively inefficient, hence leading to unemployment and a decline in

economic growth.

Also depreciation affects businesses as it deters investment in the UK, hence it

can also lead to cost push inflation in the long run hence making goods uncompetitive.

As exports are cheaper in the US Dollar and imports are expensive in pounds.Although if goods are imported which have inelastic demand in the UK, then


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1068 words

2.5 Malaysia Ringgit (MYR) Against United States Dollar (USD)

2.5.1 Introduction

As for this section, it is divided to three parts. First, a brief description on the

path of the currency wars between the MYR and USD in the past twelve months.

Second, some key factors that contributed towards the fluctuation of the MYR as

shown in Figure 5.1 and Table 5.1 and some explanations on the relationship between

these factors with exchange rates theories. Finally, the advantages acquired when the

MYR appreciated in terms of economics and business implication in Malaysia.

2.5.2 Path of The MYR in The Past 12 Months

According to Figure 5.1: USD/MYR 365 Day History (US Dollar (USD) to

Malaysian Ringgit (MYR) Exchange Rates History, 2010), in the last 1 year from 3 rd

of November 2009 until 2ndof November 2010 the MYR has appreciated against the

USD. In other words, in 3rd of November 2009 MYR currency holders will need to

spend more MYR in order to purchase the USD. As compare to in 2 ndof November

2010, they need lesser MYR to purchase the USD. A simple example to illustrate thisis by looking at the value in those two dates. According to the figures acquired from

Table 5.1: Table of 1 US Dollar to Malaysian Ringgit Exchange Rate (US Dollar

(USD) to Malaysian Ringgit (MYR) Exchange Rates History, 2010), in 3rd of

November 2009 we need 3.4366 MYR to buy 1 USD. As for the more recent date, we

need 3.0866 MYR to buy 1 USD.

This shows that the strength of the MYR is greater now as compare to the past

1 year. A simple calculation will give us the percentage of change for the year ending

2nd of November 2010 to the past 1 year. Take 3.4366 and subtract 3.0866. Thats

0.35. Then divide 0.35 by 3.4366. Thats 0.1018. Now multiple by 100 and it gives us

10.18%. To further explain, the MYR has appreciated by 10.18% from 3 rd of

November 2009 to 2ndof November 2010.

2.5.3 Key Factors That Contributed Towards Fluctuation

There are many factors that influence the fluctuation of a currency. The mostnotable factor is the economic factors of a given country. In this case, Malaysia. One


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of such economic factors is the trade deficit or surpluses. (Factors That Are

Influencing The Foreign Exchange (Forex) Market, 2010) In the past few years the

US has been suffering from trade deficit. In addition, Malaysia has managed to reduce

its trade deficit by signing the free trade agreements (FTAs) with Bangladesh and

India.

This agreement gives Malaysia a chance to export more to these two countries

and vice versa because it mainly constitutes three goals which are; increase trade

between member countries, reducing product prices and improve political bond

between countries. (FTA with India and Malaysia, 2010) The first FTA affects the

demand and supply of currency for all three countries. This is related to an exchange

rate theory; the monetary approach within the asset-approach models. The exchange

rate is determine by money demand and supply between the countries. (Chapter 18

Exchange Rate Theories, 2010) The more goods are exported the more MYR is

demanded. Thus, the MYR appreciated.

Another economical factor is increase or decrease in price inflation. In the past

one year the inflation rate in Malaysia have drastically lowered. According to CIA

World Factbook cited in Malaysia Consumer Rate (consumer prices) (2010), the

inflation rate for consumer prices in 2009 was 5.4% but in early 2010 it was 0.4%

(refer to Table 5.2: Malaysia Inflation Rate (consumer prices)). From this source it

shows the inflation rate is significantly lowered. Since low inflation rate increases the

purchasing power within a country, Malaysians will tend to spent more within the

country which leads to lower import entering the country. Therefore, the MYR

appreciated. As for this factor it also related to the monetary approach theory.

Another factor that contributed towards the appreciation of a currency is the

currency crisis (Foreign Exchange MarketForex 2009, 2010). The crisis is referring

to USs inability to clear its external debt. For example, China was the world largest

US reserves holder with a figure of 2 trillion USD. Another example is the US keep

printing money to buy bonds. By doing so, the USD will not just fall considerably in

the long run but will also lead to an inflation in bond price. (Pritchard, 2009) To

further explain, everyone knows that the US was the world leading importer. All these

explanations are what justified US gross external debt of 13,984,097 million USD as

of 30 June 2010 (U.S. Gross External Debt, 2010). With such currency crisis took


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place, USD further depreciation is imminent. As a result it will affect all other

currencies in the world to appreciate against the USD.

2.5.4 Advantages of MYR Appreciation

In the case where MYR appreciates there are a number of advantageous merits

to Malaysia. One of the obvious reason is it help balance the payments adjustment.

One of the reasons why MYR appreciates is because Malaysia has trade surpluses.

This is because exports will be greater than imports meaning the supply of MYR on

the foreign exchange will be decreasing as importers buy MYR to pay the imports.

The effect of appreciation will make Malaysian exports more expensive and imports

cheaper, thus lowering demand for Malaysian goods and increase demand in overseas

goods. Therefore, dealing with the balance of payments or the trade surpluses or

deficit problem. (The advantages and disadvantages of floating exchange rates, 2010)

In addition, appreciation of a currency may help lower gross external debt.

Malaysia is now able to pay back twice as easy because its MYR value is higher than

before. Since the MYR is not a fixed rate and is currently appreciating, Malaysia do

not need to but and hold a large amount of foreign currency such as the USD in order

to prepare for a time when they have to defend that fixed rate. By eliminating the needfor foreign exchange reserves, Malaysia does not have to worry about that extra

expenditure. (The advantages and disadvantages of floating exchange rates, 2010)

2.5.5 Conclusion

In conclusion, it is clear that the MYR have appreciated against the USD. The

discussion justified that reducing trade deficit, reduce in consumer price inflation and

USs massive gross external debt are some of the many factors that contributed to

MYR appreciation. Advantages of appreciation to Malaysia have also been assessed

where now it is certain as to how it benefited the county. The government may

intervene in fluctuation of the currency through the central bank. In order to stabilise

the MYR, the Malaysian government may use Bank Negara to increase or decrease

the interest rates. This will promote or discourage foreign direct investments (FDIs).

(Zehra, 2010)

1098 words


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Figure 2.5.1:

USD/MYR 365 Day History, (exchangerates.org.uk, 2010)

Figure 2.5.2:

Table of 1 US Dollar to Malaysian Ringgit Exchange Rate: Updated: 03/11/10 00:13

DateUS

Dollar

Malaysian

RinggitLink

Tuesday 2

November 20101 USD = 3.0866 MYR USD MYR rate for 02/11/2010

Saturday 2 October

20101 USD = 3.0758 MYR USD MYR rate for 02/10/2010
http://www.exchangerates.org.uk/USD-MYR-02_11_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_11_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_10_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_10_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_10_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_11_2010-exchange-rate-history.html


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Thursday 2

September 20101 USD = 3.1254 MYR USD MYR rate for 02/09/2010

Monday 2 August

2010 1 USD = 3.1593 MYR USD MYR rate for 02/08/2010

Friday 2 July 2010 1 USD = 3.2329 MYR USD MYR rate for 02/07/2010

Wednesday 2 June


Sunday 2 May


Friday 2 April 2010 1 USD = 3.2462 MYR USD MYR rate for 02/04/2010

Tuesday 2 March


Tuesday 2

February 20101 USD = 3.4181 MYR USD MYR rate for 02/02/2010

Saturday 2 January


Wednesday 2

December 20091 USD = 3.3771 MYR USD MYR rate for 02/12/2009

Tuesday 3


Monday 2


Minimum: 3.0645 MYR: 15 Oct 2010, Maximum: 3.5588 MYR: 12 Oct 2009, Average: 3.2782 MYR: 1 year

Table of 1 US Dollar to Malaysian Ringgit Exchange Rate, (exchangerates.org.uk, 2010)
http://www.exchangerates.org.uk/USD-MYR-02_09_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_09_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_08_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_08_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_07_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_07_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_06_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_06_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_05_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_05_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_04_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_04_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_03_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_03_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_02_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_02_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_01_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_01_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_12_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_12_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-03_11_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-03_11_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_11_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_11_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_11_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-03_11_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_12_2009-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_01_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_02_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_03_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_04_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_05_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_06_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_07_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_08_2010-exchange-rate-history.htmlhttp://www.exchangerates.org.uk/USD-MYR-02_09_2010-exchange-rate-history.html


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Figure 2.5.3:

Malaysia Infation Rate (consumer prices)

Year Inflation rate (consumerprices)

Rank PercentChange

Date ofInformation

2003 1.90 % 168 2002 est.

2004 1.10 % 189 -42.11 % 2003 est.

2005 1.30 % 31 18.18 % 2004 est.

2006 3.00 % 90 130.77 % 2005 est.

2007 3.80 % 111 26.67 % 2006 est.

2008 2.00 % 40 -47.37 % 2007 est.

2009 5.40 % 89 170.00 % 2008 est.

2010 .40 % 31 -92.59 % 2009 est.

Malaysia Inflation Rate (consumer prices), (indexmundi.com, 2010)


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2.6 Germany Euro (EUR) Against United States Dollar (USD)

2.6.1 Introduction

The aim of the following chapter is to investigate the impact of exchange rates

fluctuation currency wars on the German economy and its currency, the euro. As

the euro is also used by other countries, and as the German government does not have

a control over its national currency any longer, the discussion has to include the

European Union and the European Central Bank.

2.6.2 EUR/USD Exchange Rate Analysis

The graphs below, which visualise the value of the euro against the dollar and

the yuan, are strikingly similar.

Figure 2.6.1 EUR/USD Exchange Rate Graph

EUR/USD Exchange Rate Graph, (Onet, 2010)


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Figure 2.6.2 EUR/CNY Exchange Rate Graph

EUR/CNY Exchange Rate Graph, (Exchangerates, 2010a)

The American policy of quantitative easing was gradually appreciating the

euro. Because the yuan is pegged to the dollar, when Americans apply quantitative

easing, the value of the euro appreciates against both the dollar and the yuan. This

makes German export less competitive in the largest global markets. The value off the

euro against the dollar was steadily depreciating between November 2009 and June

2010. It was powered by the unfolding European debt crisis. Then, however, the trend

changed and the value of the euro against the dollar has fallen by 20% since June

2010. Hopefully for the Germans, the Japanese currency, the yen, had been strong fora long time, helping the German economy to recover (Satyajit, 2010). Although the

value of the EU currency against the yen and the Swiss franc had been falling for

many months, also in these cases the exchange rates have either stabilised or

weakened the euro (Exchangerates, 2010b).

The main concern of the countries whose currencies appreciate is export

competitiveness. Being the third largest exporter in the world (CIA, 2010), Germany

is especially exposed to that risk. Although German export is growing now, there are


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signs of slowing down due to the falling dollar. Exports had dropped in July and

August 2010. German exporters are afraid that a new wave of QE in the US will entail

a vicious spiral of devaluation, which would hit Europe the most. German export is

fueled by constantly developing countries, most notably China, but questions are

being raised if the currency skirmishes will not provoke protectionism, which would

close developing markets for German companies (Schafer, 2010). The situation does

not seem to be improving. Industrial orders tumbled by 4% in September compared

with the previous month (Atkins, 2010).

It should be stressed here that the situation of Germany is more complex than

that of the US or China and the consequences of currency wars on the German

economy and policy may be troublesome in a very long run. Germany has been the

engine of European economy since the end of the Second World War. It is the most

populated country in Europe (excluding Russia) and its GDP is far bigger than that of

UK, France or Italy, scoring as the forth one in world ranks (Worldbank, 2010). In

reality, the euro is much more a German legal tender than French, British or any

other. Suffice it to say that the German mark, which was replaced by the euro, was the

second global reserve currency as early as at the beginning of the nineties (Lewis,

2001: 136). As Germany is tied to EU law and institutions, and often bears the highestresponsibility for the UEs well-being,2 it is also affected by other EU members

performance and does not have complete freedom in terms of its monetary policy. It

would not be an exaggeration to say that the fate of Germany is dependent on the EU

and it is in the Germans interest to think in terms of the whole European Union.

It follows from previous consideration, that if currency wars worsen EUs

situation, they will also harm Germany. First, Germany and other countries (including

non-EU states, like Norway and Switzerland) transfer huge amounts of money to the

newly admitted EU states. The majority of this money has to be spent on

infrastructure and environmental solutions. When the prices of American and Chinese

goods fall, as a result of making the dollar and the yuan artificially weak, these new

UE members (Poland, Romania, etc.) will order goods from outside the European

Union, depriving French, British, and especially Germany companies of their

revenues. Secondly, currency wars destibilise currency markets, which entail

1As could be observed during the Greek crisis.


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problems for the countries that are planning to adopt the euro. To do that, they have to

fulfill rigorous requirements.3 If they encounter problems with that, then either the

expansion of the Eurozone will be hampered or Germany will have to contribute

again.4

At the same time, a lot of European, and not only European countries, opted

for QE or other forms of regulating money supply. Britain employed quantitative

easing already in 2009 (Giles, 2009). Recently also Switzerland attempted to weaken

its currency (Hotten, 2010). To take the argument further, countries like Russia or

Poland, important trade partners and investment sites for Germany, are conscious

about the value of their currencies and ready to intervene (Evans-Pritchard, 2010).

This complicates both economic and political relations between Germany and its

partners.

The European Central Bank responded differently to the spread of QE policy

than many other countries did. It resigned from injecting money into the banking

sector and focused on tightening monetary policy. This has already led to higher

interest rates, which can encourage foreign capital to invest in Germany and other

Eurozone members. This can create a risk of stock market bubbles (Tilford, 2010).

2.6.3 Conclusion

The currency wars brought competition to internal EU markets. Germany, and

other Eurozone countries, had to adjust their policy to the changing market situation.

The European Central Bank did not follow other central banks and did not embark on

increasing money supply through QE, and it is praiseworthy. By doing so, the EBC

seems to be far-sighted, and there is unlikely prospect off excessive inflation in the

Eurozone. However, as the Americans are not going to resign from their policy,

Germany is definitely losing its export chances. The abundant orders from developing

countries are optimistic, but they may also help German managers forget about the

losses they suffer in international markets. Finally, what is good for Germany is not

necessarily good for weaker Eurozone members.

1048 words

2Known as the euro convergence criteria or Maastricht criteria.

3Such intervention would, most likely, be conducted with the use of European institutions, like the ECB.


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3.0 Conclusion

In final conclusion, it is clear that competitive devaluation was referring to an

attempt to devalue the currency to serve a specific purpose. Although in the current

economy, most currencies around the world are appreciating against the USD but this

does not mean that the implications of depreciation should be neglected. After

assessing the six countries it is found that the implications of competitive devaluation

can be summarised into four subtopics. They are the interest rate, inflation, economic

growth and trade balance. Actually, all these subtopics are closely related to each

other. Competitive devaluation will have implication on interest rates due to its direct

connection. When the value of a currency drops, the government will increase the

interest rates through the central bank. By doing so, this will encourage more foreign

direct investment, borrowings and exports.

Higher exports and lower imports will balance the trade deficit problem.

Furthermore, if the banks issue more loans, the returns as applied to the interest rates

will be more profitable. These will ensure economic growth in the long run especially

with the presents of FDIs. Devaluation of a currency can also affect consumer price as

it affects interest rates. When a currency is devalued, the people will need to spend

more on purchasing import products. This shows an increase in inflation rate for

overseas product as well as bond price and foreign exchange reserves price. From here

it is concluded that competitive devaluation will have many implications. All these

implications consist of significant effects on the global and domestic economy.

256 words


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Global Economy Currency War

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