Currency manipulation and its impact

Fri, 12 Nov Pre-Open

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The subject of 'currency wars' is a hot topic on the stage of global economics. US and other western countries have been accusing China of manipulating their currency. This is supposedly hurting global trade and in turn the global recovery.

So let us try and understand exactly what is meant by currency manipulation and how it affects global economy.

In a market, the value of a country's currency is determined by the macroeconomic conditions in the country. This means that factors like its GDP growth, interest rates, government policies, etc. determine the value of the currency in the foreign exchange market.

However, countries like China have interfered in the natural market dynamics. China has been selling its own currency in the foreign exchange market on one hand. This action depresses the value of its currency. On the other hand, it has been constantly buying currencies of other countries, especially the US dollar and building up its own foreign exchange reserves. The combination of these actions ensures that the value of Chinese currency remains at a low constant rate.

This puts China in a position of advantage. Its exports become way cheaper when compared to the exports of other countries. This gives it a competitive edge in the market.

But we ask ourselves what is wrong with this? After all, isn't a country responsible for ensuring continued growth for itself? The answer is not that simple. Try and consider a scenario where all countries decide to adopt the same policy. Everyone's exports would be priced at similar prices and all countries would be pushing hard to sell their own goods. Under such a scenario, who would buy the products that each country is trying to export? There would only be sellers and no buyers. This would send the global economy into the dumps.

This has been the main reason why the developed world, especially US, has been putting pressure on China to allow its currency to be guided by macroeconomic factors. However, we suppose their words would have more impact if they themselves do not try to resort to similar techniques for manipulating their own currencies. US has recently announced a US$ 600 bn programme of quantitative easing. This printing of money will lead to the devaluation of the US dollar. Some experts feel that this is US' way of manipulating its currency. So when will this currency war end? It remains to be seen.