Currency wars - beggar thy neighbour

The last few weeks have seen tension heighten significantly between nations over the issue of currency valuations and their effect on international trade. The main protagonists are, not surprisingly, the US and China, the two largest economies in the world.

Ted Scott, Director, UK Strategy at F&C, investigates the possibility and consequences of an international trade war in a note entitled "Beggar thy neighbour: will there be an international trade war and what would the consequences be if there was one?"

In his note, Scott examines how one of the main reasons another Great Depression was avoided was due to better, international cooperation, particularly amongst G20 countries who co-ordinated the implementation of monetary and fiscal policies. That sentiment has now changed; the US has recently escalated a war of words, partly laying the blame for its disappointing economy with China via its exchange rate policy that effectively pegs its currency, the Yuan, to the Dollar. According to the US, this materially undervalues the Yuan and leads to the creation of China's massive trade surplus by making its goods unfairly competitive in the world market. The US has threatened to take direct action if China does not change its currency policy to allow the Yuan to strengthen.

Scott's note outlines why we should heed the warnings from history - when international trade tensions have had a deleterious effect on the world economy - to avoid the same mistakes. The 1930's was the most profound but more recently the devaluation of the dollar in the 1970's and 80's has clear overtones with what is happening today.

There are now challenges confronting other countries, largely as a consequence of the bilateral sparring between China and the US. Brazil has expressed concern that the rising value of the Real is harming the country's export business. Other countries, such as Thailand and South Korea, have also seen the value of their currencies rise as a result of the amount of capital inflows. Most recently, and more significantly, Japan has sold Yen in the foreign exchange markets in order to suppress its value which has been harming its export led economy.

Scott concludes: "The two main protagonists, China and the US, both have strong cases however they need to compromise over their clear differences to prevent a tariff war and economic isolationism. In this respect, much can be learned from history. In particular, the US needs to recognise that it, as much if not more than China, is to blame."