Currency War

There are many ways to fight a war.  You can have an old fashioned shooting war with a tremendous amount of destruction, or you can build deterrents and alliances through a more careful Cold War.  When things get really bad, however, it’s far more traditional to have a Currency War.  That’s what Brasil’s Finance Minister Guido Mantega called the world economy recently, putting a name and a bit of Brasilian bluntness to a situation that’s been brewing for a while.

It seems simple enough, like most macro-economic policy.  You make your currency worth less than every other nation and suddenly the goods that your nation produces look pretty cheap.  The risk is that everything you import becomes more expensive, lowering your standard of living, but when there are unemployed workers to make bizzy governments rarely worry about that.  Once a Currency War gets started, however, every nation does what they can to trash their currency and soon it all comes out about where we all started – except the whole world is broke, angry, and a bit desperate.

Sometimes, it leads directly to a more old fashioned kind of war.  But let’s leave that alone for now.

The real problem with a Currency War is that it is very enticing.  All national currencies are traded on the foreign exchange market, which is subject to the same laws of supply and demand as anything else.  If you are the tiny nation of San Marco all you have to do is ease credit, run big deficits, and generally spend the San Marco Peso like crazy and pretty soon there is a lot more of it on the world market than people really want.  The value of the San Marco Peso drops and exports from San Marco are so cheap that your factories can’t keep up with the orders.  What Finance Minister wouldn’t want to give it a whirl?

In a normal situation what keeps smaller nations like our fictional San Marco in check are the big nations, big banks and the International Monetary Fund (the large international bank of last resort).  If they yank San Marco’s credit line for being a little too lose with their cash the party stops in a big hurry.  But right now all these institutions are terribly busy with problems of their own right now, trying to keep the whole world economy moving one way or another.  Once a Currency War tempts big nations, the little ones get the green light to accelerate it and soon the whole world is awash in paper.

It happened in the Great Depression and it’s happening in this, what I’m starting to call the “Managed Depression”.

No matter what all the august institutions might say about a situation like this, the real force that prevents a Currency War from starting are the foreign exchange (or ForEx) traders. They are seen as specialists in a dark art by most financial analysts, but ForEx people are really generalists – they get to know tiny economies like San Marco’s up and down, reading the politics and social trends for hints of increased debt and risk of default.  The reason that the ForEx traders haven’t been able to have the influence necessary to prevent this situation is that they tend to be a bit of a downer once the party gets started.  Many were telling us what might happen long ago, but no one wanted to listen.

Ignoring the ForEx traders was a failure of the free market, not government institutions.  Ultimately, however, this Currency War comes back to one of the problems inherent in a democratic republic where voters demand policy changes to improve their own situation.  Our world has become just global enough that what happens in San Marco influences our lives but not global enough that most people are capable of paying enough attention to what’s really going on in the 180-something San Marcoses that dot the globe.

What’s next in the Currency War?  Don’t think for a minute that big governments like the US, UK, and Japan aren’t about to fire their own big guns filled with wads of cash – and have already started doing this on a small scale.  That leaves responsible nations that have their act together in a bind because a growing second-tier economy benefits greatly from global stability, the first thing to go in a real Currency War.  Yes, Brasil spoke out on the topic for their own local reasons in an election year, too.  That’s the great problem at the heart of a global Currency War, after all.

(Bonus points to anyone who knows why I used the fictional nation of San Marcos!)