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    A Currency War between the US and China will boost the Dollar

    August 2019

    When the US declared China a currency manipulator, long-building trade tensions between the world’s two largest economies spread to the combustible realm of currencies – with potentially huge consequences for the global financial system should the escalation continue.

    Central banks in India, New Zealand and Thailand cut interest rates, aiming to protect their economies from the fallout of the trade and currency war. And bad numbers on industrial production in Germany heightened fears of a recession in Europe. Money flooded into safe assets, especially US Treasure bonds. But in my opinion the wave of worry around the world has its roots in the fraught relationship between China and the US.

    Did China allow the value of the renminbi to fall against the dollar so it would better match the nation’s economic situation, as the country’s leaders and many international economists argue? Or was it, as President Donald Trump contends, an effort to give Chinese exporters an unfair advantage in trade?

    That clash reflects Trump’s rejection of the consensus of global economic policymakers, which says countries should be free to set monetary policies aimed at sustaining growth, even if that causes their currency to depreciate. There’s also a general agreement that nations should be free to manage their exchange rates so long as they keep them broadly in line with their economic fundamentals.

    The conflict also reflects the president’s singular focus on reducing trade deficits, which he has argued make the US a loser in the global trade system. But waging a currency war could come at a big cost. I further worry it undermines the international framework that has supported decades of faster growth. Exchange rates have turned into the shock absorber in the global economy. When a nation enters a recession, its currency tends to fall, which helps its export industries and can help lessen the severity of the recession or create a pathway out of it.

    There have been international strains over currency valuations for years, all the more so in a world in which all the major economies are coping with sluggish growth. But the newest currency frictions are different.

    Up until now, countries have been focused on stimulating their domestic economies. In particular, central banks have cut interest rates and taken other steps to pump money into their financial systems – actions that tend to lower the value of their currency. After all, investing in a currency with lower interest rates is less attractive, all else equal, than in one with higher rates.

    But the conventional wisdom among international economists is that this doesn’t count as currency manipulation. It’s not a game in which one country’s win means another’s less. Lower interest rates should generate more economic activity, which makes the whole world better off.

    The Trump administration has introduced a zero-sum approach to global currency policy – envisioning a loser for every winner- that violates the spirit of those rules. In that sense, latest moves risk upsetting a relatively stable order, creating unpredictable ripple effects. When currencies swing wildly, entire economic sectors can be crushed even in powerful nations if these sectors find themselves uncompetitive after a swing in global exchange rates.

    And in my opinion it could undermine the central role the US has played in the international financial system, especially if the accusations of manipulation are followed up with concrete retaliation to try to artificially depress the value of the dollar. The dollar being the primary global currency has enormous benefits for the US, but with the side effect that when the US tries to depreciate, there are limits on how much it can in my opinion do that. But if the US abuses its privilege too much by bullying, there will eventually be a switch.

    The decision to name China a currency manipulator does not, in and of itself, do much. But it could be followed up with pressure on the International Monetary Fund (IMF) and other nations to make similar findings and lean on the Chinese to adjust their policies. Or it could lead to direct intervention in foreign exchange markets by the US Treasury.

    The Trump administration’s decision to name China a currency manipulator – for allowing the value of its currency to fall – does not align with how mainstream economists view China’s move.

    In my opinion it’s dangerous to start a currency war because no one knows where it will end. We’ve seen with the trade conflict that it started in one place, escalated into a trade war and ended up much broader.

    There’s every risk a currency war will do the same.