Currency Wars!

The problem with terming what is happening in the exchange markets as "currency wars" is that its not in line with how the markets are working. There are several reasons for this. 

If one was to believe in the (in)famous Efficient Market Hypothesis, markets have already factored in all the information coming their way in the form of predominantly low interest rates in the G3 economies and their clear intentions to stay at those levels (The ECB and BoE have not changed their stance for many months now). Even if one was not a staunch adherent of this theory, what is happening now, can be termed as the obvious byproduct of monetary and fiscal policy followed by the G3, especially the US, rather than terming it as a veritable war of currencies. This is exactly what Joseph Stiglitz had to say in a recent interview following the IMF meetings this weekend. Keeping interest rates low has inadvertently lead to this low intensity diplomatic standoff. In any case, the term seems to be an exaggerated media headline.

USA faces a tremendously huge trade deficit right now, reminiscent of the later parts of the Reagan era. The easiest way for a country with its own currency to fight back to be competitive in its exports is to devalue the currency. The US is doing exactly that but is getting caught up in a battle for competitiveness of its exports with the developing world, especially with the artificially low CNY.  However, it is pretty self evident that China is going to appreciate its currency slowly, taking its own time, and perhaps they are justified in doing so until there is some new (anti) Bretton Woods kind of agreement within the G20 community (possibly this might be discussed in the upcoming conference in Seoul?). What gives a nation the right to be protectionist can hardly be dictated by the whims of another, since in that game everyone is a hypocrite!

Meanwhile, developing countries such as India and Brazil will continue to reap the benefits of inflowing capital, invested by developed world to avail of higher interest rates. At the same time, they must be prepared for the unknown, and be aware of the risks of a flight to quality by investors by imposing better capital control measures. Living in a fools paradise is only going to ensure the infallibility of the Greenback and the status quo to continue for a long time to come.