Currency Wars: Precursor to Trade Wars
article by Paul Kieffer
A stunning move by the Swiss National Bank in September signals the opening round of a currency war as Switzerland sets exchange limits to protect its domestic economy. What are the ultimate repercussions of such actions?
A Swiss franc bank note.
Source: Wikimedia CommonsIn a dramatic move on September 6, 2011, the Swiss National Bank (SNB) provided Swiss businessmen the support they had been seeking for months. At the opening bell for European stock and financial markets, the SNB declared that further value increase of the Swiss franc relative to the euro would not be tolerated. Instead, a minimum exchange rate of 1 euro to 1.20 Swiss francs would be maintained—the bank purchasing euros in whatever quantity necessary to support this rate.
The announcement stunned European financial markets. The value of the Swiss franc dropped more than 8 percent within minutes, and the price of gold dropped by 2 percent. When trading ended later that day, the Swiss franc had achieved its target valuation of 1.20 francs to the euro and has since remained at that level—or lower.
The SNB's decision was a surprise following its failed attempt last year to limit the rise in value of the Swiss franc relative to other currencies. Financial analysts characterized 2010 as a year of currency jockeying and tension as various central banks attempted to prevent their currencies from strengthening. Repeated intervention by the SNB left its foreign currency accounts bloated and resulted in an annual loss of 20 billion Swiss francs for the year, but had little effect on the franc's value.
Why would a country want to keep its currency valuation low? It encourages foreign trade and tourism. With Switzerland's small free-market economy, its lack of extensive natural resources and its strong dependence on foreign trade and tourism, the country is hurt when the value of its currency is too high against other currencies.
A few large multinational Swiss companies have production centers in other currency regions. By utilizing production capacity outside Switzerland as needed, they can mitigate losses from an adverse exchange rate to some extent. However, small and mid-sized businesses—a major contributor to the Swiss economy (as in Germany also)—do not have that option. The appreciation of the Swiss franc is especially challenging for exporters. To prevent their products from becoming too pricey in foreign markets, a few companies had even asked employees to work extra hours with no increase in pay. Switzerland's tourism industry also voiced concern that a strong Swiss franc would have an adverse effect on revenue.
In the aftermath of the SNB's surprise announcement, financial analysts predicted that speculators would test the central bank's commitment to maintaining its target exchange rate. With some $230 billion (U.S.) in exchange reserves, the SNB appears to have adequate funds to meet the challenge.
Yet what does this mean for international trade and relations? Where do such steps eventually lead?
Currency instability: nothing new under the sun
The SNB decision on September 6, 2011, reminded me of a day in August 40 years earlier. At the time I was working as a technical assistant at a business consulting firm near Hanover, Germany. In the afternoon a colleague burst into the room to tell me that German news media had just reported an important decision made by U.S. President Richard Nixon.
On August 15, 1971, Nixon announced that there would no longer be any official exchange rate between the U.S. dollar and gold. As part of the Bretton Woods exchange rate system established after World War II, the dollar had been pegged at $35 per ounce of gold. America's promise to redeem dollars at this rate also linked other currencies in the system directly to gold. Nixon's decision was an attempt to combat an inflation rate above 5 percent and the devaluation of the U.S. dollar (resulting from the cost of the Vietnam War) and to prevent further depletion of America's own gold reserves. As the excess of printed dollars grew in the late 1960s and through 1970, other nations began to demand that America fulfill its gold redemption promise. For example, Switzerland redeemed $50 million of paper money for gold in July 1971.
As one of several unilateral moves made by the United States since World War II, Nixon and his advisers took action without consulting other members of the international monetary system. Foreign governments and central banks heard about the decision the same way the general public did—through the news media as Nixon delivered his speech. The announcement was made before U.S. markets opened and just as Asian markets were opening for the next trading day. The "Nixon shock," as the world's financial community called it, effectively ended the postwar Bretton Woods exchange rate system and gave rise to the current floating (or flexible) exchange rates between currencies.
Floating exchange rates as a source of conflict
In 1996, Paul Krugman, winner of the 2008 Nobel Prize for economics, commented on the inherent dangers of a floating exchange rate system: "While a freely floating national money has advantages, however, it also has risks. For one thing, it can create uncertainties for international traders and investors.Over the past five years, the dollar has been worth as much as 120 yen and as little as 80. The costs of this volatility are hard to measure (partly because sophisticated financial markets allow businesses to hedge much of that risk), but they must be significant. Furthermore, a system that leaves monetary managers free to do good also leaves them free to be irresponsible—and, in some countries, they have been quick to take the opportunity" ("The Gold Bug Variations," Slate, Nov. 22, 1996, emphasis added throughout).
The current system also gives central banks the freedom to manipulate the value of their currency to promote price advantages for their country's goods and services in the international marketplace. The Swiss National Bank's intervention to devalue the Swiss franc is a classic example. But the SNB was following the example of Japan's central bank, which had intervened repeatedly over the summer on currency markets to stem the appreciation of the yen.
Responding to America's loose monetary policy, Brazil's finance minister Guido Mantega voiced his determination to prevent an appreciation of the real, Brazil's currency. Just one week prior to the SNB announcement, Brazil's national bank had lowered interest rates by half a percentage point in an attempt to reduce foreign capital inflow, which threatened to make the real—and Brazil's exports—more expensive.
Many in the United States see China as the world's biggest currency manipulator. A number of economists claim China artificially prevents the value of its yuan currency from rising, providing Chinese exporters an edge in global markets. As one of China's main trading partners, the United States is flooded with cheap products, contributing to the large U.S. trade imbalance.
On October 11, 2011, the U.S. Senate approved a measure requiring that if the Treasury Department determines that China improperly values its currency to gain economic advantage, the Treasury is to order the Commerce Department to impose new tariffs (import taxes) on various Chinese products. Yet while the yuan has appreciated by 30 percent against the dollar since 2005, the administration of U.S. President Barack Obama has refrained from labeling China a currency manipulator and does not support the Senate bill (which still has to gain approval from the House of Representatives before it would be sent to President Obama for approval or veto).
Prior to the Senate vote, China's central bank and its ministries of commerce and foreign affairs had accused U.S. lawmakers of using the currency exchange rate issue for political advantage and thereby exposing the global economy to the risk of a trade war.
The tension with China over its currency valuation mirrors comments made by currency strategist Maurice Pomery after the SNB announcement to support the Swiss franc: "The start of full-on currency wars has begun in earnest. After currency wars come trade wars,and as we see the exporting world pressured as the developed world contracts, tensions will rise" (Financial Times, Sept. 7, 2011).
Trade wars involve imposing trade barriers or raising tariffs on imports—taxes that make the imports more expensive so consumers are less likely to buy them. Unfortunately, this typically results in domestic producers raising prices due to less competition—meaning an overall rise in prices of goods.
Furthermore, as the U.S. dollar weakens, a major move likely to increase currency and trade tensions would be the use of another currency as the benchmark for pricing major commodities, especially crude oil.
After trade war comes hot war
The experience of history teaches that trade wars should never be taken lightly. Trade wars have often contributed to military conflict, and World War II was no exception. Gaining access to natural resources was a factor in both German and Japanese aggression and the resulting occupation of conquered territory.
The apostle James highlights this principle in his biblical epistle: "What causes wars, and what causes fightings among you? Is it not your passions that are at war in your members? You desire and do not have; so you kill. And you covet and cannot obtain; so you fight and wage war. You do not have, because you do not ask. You ask and do not receive, because you ask wrongly, to spend it on your passions" (James:4:1-3[1]From whence come wars and fightings among you? come they not hence, even of your lusts that war in your members?[2]Ye lust, and have not: ye kill, and desire to have, and cannot obtain: ye fight and war, yet ye have not, because ye ask not.[3]Ye ask, and receive not, because ye ask amiss, that ye may consume it upon your lusts., Revised Standard Version). James is addressing individuals, but what he writes about individuals also applies to entire nations.
Bible prophecy reveals a time of worldwide conflict prior to the return of Jesus Christ. Various prophecies reveal major world powers that will vie for world leadership. One power will be among the English-speaking peoples who have inherited the physical blessings promised to Abraham for his obedience. The leading nation of these modern-day Israelites is the United States, currently the world's leading military and economic power.
Another power center will be a revived Holy Roman Empire, located in its traditional area of influence in Europe. Revelation 18 describes this end-time system as an economic powerhouse with worldwide influence through its far-reaching system of trade and commerce. Yet another world power will be the "kings of the east" (Revelation:16:12), whose forces will cross the Euphrates River and enter the Middle East as part of the final struggle for the control of this region.
The Bible also foretells the existence of an end-time "king of the South" (ruler of a power south of Jerusalem that will likely include Egypt and other Islamic states) who will provoke the "king of the North" (ruler of the revived Holy Roman Empire) into taking military action and occupying portions of the Middle East. One possible contributing provocation would be the withholding of an economic asset like petroleum. And access to the Middle East's petroleum reserves would be important for the "kings of the east" as well.
A time of worldwide conflict lies ahead. Access to natural resources and international markets will again contribute to that end-time conflagration. The ongoing jockeying among central banks to position national currencies advantageously for international trade is a precursor to increasing international tension.
Our free booklets The Book of Revelation Unveiled and The Middle East in Bible Prophecy give more details about where events will eventually lead—to the harrowing crisis at the close of this age that will ultimately see the return of the King of Kings, Jesus Christ. Following the worst time in human history, He will at last lead all nations out of darkness and into peace, prosperity and true happiness.
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