101015_Clarifier

Brazilian Finance Minister Guido Mantega is not happy. He reckons other economies are trying to cut the South American powerhouse’s empanada by artificially devaluing their exchange rate and that the world is in the midst of an “international currency war”.

Mantega’s anger reflects the latest stoush in the long-running battle between developed and emerging economies over the efforts of some countries to keep their exchange rates low, in order to stimulate demand. So are we in for a full-scale currency war? Crikey went scouring the interwebs for the answers…

What are some of the factors behind the so-called currency wars?

Mantega’s recent anger is aimed at countries like Thailand, Columbia and Japan which have taken measures to weaken their currency in the hope it will lead to increased exports and hasten economic recovery. Emerging economies like China, India and Brazil are producing cheaper goods being sold at prices developed economies can’t compete with.

What tools do central banks use to devalue their currency devalued?

Central banks can maintain a low exchange rate by buying US dollars (or selling domestic currency), imposing a tax on foreign capital inflows or using taxation laws to increase currency supply. Thailand announced a new 15% withholding tax for foreign investors in its bonds, while Japan recently put around 1 trillion Yen onto the money market, which saw the currency tumble.

What about quantitative easing?

Some established economies have begun ordering that their central banks may soon restart quantitative easing — otherwise known as printing money — to buy government bonds.

The US has been an active player in this area, with the Federal Reserve expected to engage in a fresh bout of quantitative easing next week. The flood of dollars can be used to buy treasury bonds, which will increase the world’s supply of greenbacks and leading to the US currency tumbling further. The US is hoping a devalued dollar will help it compete with the flood of cheaper goods from emerging economies like China.

What about China?

China has been the target of much of the scorn, due to what many critics see as their undervalued currency. A cheaper Chinese yuan or renminbi keeps the price of Chinese goods down in export markets like the US, leading to a trade imbalance between countries.

How is the Chinese currency devalued?

Until recently, the yuan was pegged against the US dollar, creating an artificial value for the currency. In June, ahead of a meeting of G20 economies, the People’s Bank of China bowed to international pressure and announced the yuan would be revalued — but only gradually. Despite this move, many maintain the yuan is still undervalued by 15%-40%.

Could we see this monetary policy spill over into a diplomatic scuffle?

Possibly. The Obama administration has increased pressure on China to allow its currency to rise, with the House of Representatives moving to impose potential trade sanctions if Beijing does not comply.

IMF chief Dominique Strauss-Kahn is also concerned by the prospect of economies relying on short-term fixes like rising exports, warning the global economy’s “initial achievements are at risk of being undermined” by currency manipulation.