Should we worry about a currency war?

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US President Donald Trump has accused the Federal Reserve of being responsible for the “very strong” dollar by keeping interest rates high.

@realDonaldTrump

“Three more Central Banks cut rates.” Our problem is not China – We are stronger than ever, money is pouring into the U.S. while China is losing companies by the thousands to other countries, and their currency is under siege – Our problem is a Federal Reserve that is too…..

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End of Twitter post by @realDonaldTrump

Twitter post by @realDonaldTrump: ....proud to admit their mistake of acting too fast and tightening too much (and that I was right!). They must Cut Rates bigger and faster, and stop their ridiculous quantitative tightening NOW. Yield curve is at too wide a margin, and no inflation! Incompetence is a.....Image Copyright @realDonaldTrump

A rate cut would not only boost the economy but, in theory at least, reduce the value of the soaring dollar.

Last month, the Fed had cut rates for the first time since 2008, with a 0.25 percentage point cut that took the federal funds target range to 2% to 2.25%.

Another way would be for the US to directly sell dollars to buy other currencies, but Ms Greene said that while the US had about $100bn of reserves which it could use to try to devalue its currency, it was not enough to make much of a difference.

“If the US is cruising for a currency war, it doesn’t actually have that many tools to win one,” she added.

us rate chart

So what happens next?

Treasury Secretary Steven Mnuchin will now engage with the International Monetary Fund (IMF) with the intention to “eliminate” what the US describes as “the unfair competitive advantage created by China’s latest actions”.

Ms Greene pointed out that the IMF had previously said China was not manipulating its currency and warned it could be a “dead end”.

It is making economists question what else the US might do, while the president’s tweets are already leading some to expect that the US could start intervening directly.

John Normand, head of cross-asset fundamental strategy at JP Morgan, said he did not think a currency war was under way yet, since the moves in the Chinese currency this week were “private-sector driven” as international investors withdrew funds from the country.

“Before Trump, people would have assumed a currency war wouldn’t happen,” he said, adding that the US president “disregards all conventions”.

What has happened in the past?

Agreements between the main trading nations have pledges not to manipulate currencies, although there have been agreements between nations to intervene in markets.

The 1985 Plaza Accord, for instance, was an agreement under which Japan, France, Germany, the UK and the US agreed to boost the value of the dollar.

In 2000, central banks intervened to drive the euro higher after the currency hit an all-time low.

And in 2011, countries jointly intervened in the currency markets to weaken the Japanese yen after it rose to its strongest level since World War Two.

Even if direct intervention in the market does not take place, Kate Phylaktis, professor of international finance at the Cass Business School, pointed out that countries can use indirect methods such as capital controls (when governments limit the flow of currencies in their countries) and monetary policy.

Leaders can also try to make public remarks that can have an impact on the value of their currencies. Such “talk” is something Mr Trump has accused the European Central Bank of, when he said in June that the fall in the euro against the dollar was “making it unfairly easier for them to compete against the USA”.

Mr Shearing points to examples where sharp devaluations have eventually – although not immediately – boosted an economy, such as Argentina in 2001 and the UK after Black Wednesday in 1992 when sterling crashed out of the Exchange Rate Mechanism.

Countries can also cause havoc when they let their currencies float freely again. In 2015, the Swiss franc soared as much as 30% in chaotic trade after the central bank abandoned the cap on the currency’s value against the euro that had been in place since 2011

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