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Authors: James Rickards
Tags: Business & Economics
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apology were not immediately forthcoming, China went beyond the July reduction in exports and halted all rare earth shipments to Japan, crippling Japanese manufacturers. On September 14, 2010, Japan counterattacked by engineering a sudden devaluation of the Japanese yen in international currency markets. The yen fell about 3 percent in three days against the Chinese yuan. Persistence by Japan in that course of devaluation could have hurt Chinese exports to Japan relative to exports from lower-cost producers such as Indonesia and Vietnam.
China had attacked Japan with an embargo and Japan fought back with a currency devaluation while both sides postured over a remote group of uninhabited rocks and the fate of the imprisoned trawler captain. Over the next few weeks the situation stabilized, the captain was released, Japan issued a pro forma apology, the yen began to strengthen again and the flow of rare earths resumed. A much worse outcome had been avoided, but lessons had been learned and knives sharpened for the next battle.
A prospective currency warrior always faces the law of unintended consequences. Assume that a currency devaluation, such as one in Europe, succeeds in its intended purpose and European goods are cheaper to the world and exports become a significant contributor to growth as a result. That may be fine for Europe, but over time manufacturing in other countries may begin to suffer from lost markets leading to plant closures, layoffs, bankruptcy and recession. The wider recession may lead to declining sales by Europeans as well, not because of the exchange rate, but because foreign workers can no longer afford to buy Europe’s exports even at the cheaper prices. This kind of global depressing effect of currency wars may take longer to evolve, but may be the most pernicious effect of all.
So currency devaluation as a path to increased exports is not a simple matter. It may lead to higher input costs, competitive devaluations, tariffs, embargoes and global recession sooner rather than later. Given these adverse outcomes and unintended consequences, one wonders why currency wars begin at all. They are mutually destructive while they last and impossible to win in the end.
As with any policy challenge, some history is instructive. The twentieth century was marked by two great currency wars. The first, Currency War I, ran from 1921 to 1936, almost the entire period between World War I and World War II including the Great Depression, with which it is closely associated. The second, Currency War II, ran from 1967 to 1987 and was finally settled by two global agreements, the Plaza Accord in 1985 and the Louvre Accord in 1987, without descending into military conflict.
Currency wars resemble most wars in the sense that they have identifiable antecedents. The three most powerful antecedents of CWI were the classical gold standard from 1870 to 1914, the creation of the Federal Reserve from 1907 to 1913, and World War I and the Treaty of Versailles from 1914 to 1919. A brief survey of these three periods helps one to understand the economic conflicts that followed.
The Classical Gold Standard—1870 to 1914
Gold has served as an international currency since at least the sixth century BC reign of King Croesus of Lydia, in what is modern-day Turkey. More recently, England established a gold-backed paper currency at a fixed exchange rate in 1717, which continued in various forms with periodic wartime suspensions until 1931. These and other monetary regimes may all go by the name “gold standard”; however, that term does not have a single defined meaning. A gold standard may include everything from the use of actual gold coins to the use of paper money backed by gold in various amounts. Historically the amount of gold backing for paper money has ranged from 20 percent up to 100 percent, and sometimes higher in rare cases where the value of official gold is greater than the money supply.
The classical gold
China had attacked Japan with an embargo and Japan fought back with a currency devaluation while both sides postured over a remote group of uninhabited rocks and the fate of the imprisoned trawler captain. Over the next few weeks the situation stabilized, the captain was released, Japan issued a pro forma apology, the yen began to strengthen again and the flow of rare earths resumed. A much worse outcome had been avoided, but lessons had been learned and knives sharpened for the next battle.
A prospective currency warrior always faces the law of unintended consequences. Assume that a currency devaluation, such as one in Europe, succeeds in its intended purpose and European goods are cheaper to the world and exports become a significant contributor to growth as a result. That may be fine for Europe, but over time manufacturing in other countries may begin to suffer from lost markets leading to plant closures, layoffs, bankruptcy and recession. The wider recession may lead to declining sales by Europeans as well, not because of the exchange rate, but because foreign workers can no longer afford to buy Europe’s exports even at the cheaper prices. This kind of global depressing effect of currency wars may take longer to evolve, but may be the most pernicious effect of all.
So currency devaluation as a path to increased exports is not a simple matter. It may lead to higher input costs, competitive devaluations, tariffs, embargoes and global recession sooner rather than later. Given these adverse outcomes and unintended consequences, one wonders why currency wars begin at all. They are mutually destructive while they last and impossible to win in the end.
As with any policy challenge, some history is instructive. The twentieth century was marked by two great currency wars. The first, Currency War I, ran from 1921 to 1936, almost the entire period between World War I and World War II including the Great Depression, with which it is closely associated. The second, Currency War II, ran from 1967 to 1987 and was finally settled by two global agreements, the Plaza Accord in 1985 and the Louvre Accord in 1987, without descending into military conflict.
Currency wars resemble most wars in the sense that they have identifiable antecedents. The three most powerful antecedents of CWI were the classical gold standard from 1870 to 1914, the creation of the Federal Reserve from 1907 to 1913, and World War I and the Treaty of Versailles from 1914 to 1919. A brief survey of these three periods helps one to understand the economic conflicts that followed.
The Classical Gold Standard—1870 to 1914
Gold has served as an international currency since at least the sixth century BC reign of King Croesus of Lydia, in what is modern-day Turkey. More recently, England established a gold-backed paper currency at a fixed exchange rate in 1717, which continued in various forms with periodic wartime suspensions until 1931. These and other monetary regimes may all go by the name “gold standard”; however, that term does not have a single defined meaning. A gold standard may include everything from the use of actual gold coins to the use of paper money backed by gold in various amounts. Historically the amount of gold backing for paper money has ranged from 20 percent up to 100 percent, and sometimes higher in rare cases where the value of official gold is greater than the money supply.
The classical gold
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