Guido Mantega, the Brazilian Finance Minister, has recently came on record declaring that there is currently an “international currency war.” What in the world is Mr. Mantega talking about?

Mr. Mantega stated in the article that nearly every country’s currency was weakening. The reasons for the weakening were different: some were because of basic economic reasons, while others were because of incorrect policy being put into place. However, what Mr. Mantega is most concerned about are countries that he feels are taking deliberate measures to depreciate their currency. Why would Brazil be so concerned with other countries deliberately depreciating their currency?

One example is that of the recent depreciation of the United States dollar. The United States is the world’s largest single importer of goods. In fact, the U.S. imports roughly 60% more then the 2nd largest importing country (China; and it’s roughly 1.6 trillion vs. 1 trillion) and nearly as much as the entire 27 country European Union (1.672 trillion vs 1.6 trillion)! That works out to roughly 16.7% of all of the world’s goods being sent to the United States! There is no denying that the value of the United States dollar must have a huge impact on world trade.

What is essentially happening here is that the value of one country's currency is depreciating, making foreign imports less attractive to that country's market, due to lower purchasing power. To an economy based on exporting, such as China, Japan, Brazil, and other mostly developing countries, that can have a devastating effect on their wealth.

There is one way to counter this effect: depreciate the exporting country’s currency relative to the importing country’s currency. This is the “currency war” that Mr. Mantega was talking about. Some of the countries that are dependant on exports are creating more currency and therefore inflation, therefore depreciating the value of their currency and making their exports more attractive to importing countries, such as the U.S.

The other motivating factor in this currency war is that the Chinese yuan is so closely fixed to the U.S. dollar (this also creates some issues which we will discuss in the next part of this series). Since China is the world’s second largest importer with 8% of all imports (bringing the total between these two countries to roughly 20% of all imports), it is easier to see why the other countries want to depreciate their currencies now. In order to keep their goods attractive imports to these two major countries, they almost have to! The central banks of South Korea, Japan, and Russia (among others) have turned to the money markets in order to keep their currency value competitive for the exportation of their goods.

What do you think? Should countries be allowed to change the value of their currencies on a whim like they are currently? Do the major countries need to talk about fixing exchange rates at the upcoming G-20? How can these currency issues be fixed?

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