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Forex trading course: What are currency wars?

Forex markets are being put under pressure by a series of competitive devaluations in a process known as currency wars.

From Japan to London, central banks are doing their best to smash their currencies in an effort to gain an export advantage.

What are currency wars?

The term refers to a series of non-explicit moves by national central banks to devalue their currencies on the international Forex markets.

In a world of stalling demand and deflation, anything that the banks and their governments can do to stimulate demand is on the table. This includes printing money, which has the effect of lowering its value. In essence, the more dollars or yen in the world, the less each one is worth.

Guido Mantega

The term currency war was first used back in 2010 by Brazilian finance minister Guido Mantega to describe competitive devaluations around the world.

Currency wars: methods

The sinews of currency warfare are the printing presses.

Printing press – quite simply banks can churn out more dollars, pounds and euros. More money in the system going after the same amount of goods and services should lead to inflation, which devalues a currency.

QE

Quantitative easing (QE) is the means by which central banks are devaluing their currencies. By buying up debt – usually in the form of government bonds - they hope to spur investors to riskier assets. Of course few admit outright to currency manipulation; it is invariably dressed up as a policy to address national problems. QE also involves the creation of more paper money, which leads to inflation. (remember inflation=currency devaluation).

Interest rates

Central banks can lower interest rates – as the ECB and the Reserve Bank of Australia have done recently. This gives investors less incentive to hold assets as they will earn lower yields. In Europe, the ECB's Mario Draghi has even hinted at negative interest rates – charging people to hold cash in the bank – to stimulate demand and inflation. (more demand=inflation).

Capital controls

As we have seen in Cyprus, there is a way to devalue your currency – stop people taking it out. This could be an increasingly appealing option for central banks as things get more desperate.

Currency peg

Banks can buy up foreign currency and sell theirs to set the exchange rate at a fixed level.

Buying foreign currency

Banks can buy up debt in other countries, which increases the demand for, and therefore value in, the other county's currency. This has the effect of devaluing your currency.

Why bother?

There are two reasons to devalue a currency: to boost exports and to improve employment. The two, of course, go hand-in-hand. Exports are good for growth, which keeps more people in jobs. Ultimately, with jobs and growth the two key pressure points for political success, it's obvious why devaluing currencies is so popular.

Negatives

Probably too many to mention. 

Currency wars in quotes:

"Let the burglary begin, the silent but deadly transfer of wealth from rich old baby boomer savers to young, feckless borrowers, from pensioners to the dwindling workforce, from individual to government," says Saxo Capital Markets UK chairman Nick Beecroft on the company's Tradingfloor platform.

European Central Bank policymaker Benoit Coeure: "As much as exchange rate movements are the natural result of policies aimed at achieving sound and legitimate domestic targets, such as price stability, and as long as other central banks are not constrained in their ability to take offsetting actions, there is no reason for concern.

"Keeping one's own house in order, however, is quite different from sticking one's head in the sand. Especially in the current conjuncture, the room for policy actions might be reduced, or countervailing interventions might have become more costly."

James G Rickards, author of Currency Wars: The Making of the Next Global Crisis, says the US Fed is "playing with a nuclear reactor". Speaking at the Global lnvestment Risk Symposium, he explained: "They think they are not. They think they are playing with a thermostat. But they risk melting down the system."

India's central bank governor Duvvuri Subbarao: "We all understand it is a zero sum game. Everyone can't devalue at the same time and benefit, everyone loses." 

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