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Reverse Currency Wars

High inflation and aggressive US rate rises bolster the appeal of stronger exchange rates. With elevated global inflation likely to persist for some time, the prospect of competitive exchange-rate appreciations is looming larger. Instead of a race to the bottom in the currency market, there may be a scramble to the top – and poorer countries will likely suffer the most.

The dollar hit its highest level against a basket of rival currencies in 20 years this week as traders respond to the Federal Reserve’s attempt to cool inflation with sharp rate rises. But where once central bankers outside the US might have embraced the rampaging dollar, now they feel shifts in exchange rates have added extra pressure to keep pace with the Fed

US dollar is up 12% against the euro over the past year and, at €0.93, is approaching parity. If prices of oil and other commodities now seem high in dollar terms, they look even higher in euros. With the greenback surging, and inflation in many countries currently at multi-decade highs, we may be entering so-called “reverse currency wars” – in which countries compete to strengthen their currencies’ foreign-exchange values.

The surging dollar has prompted some analysts and investors to forecast a new period of “reverse currency wars” as many central banks abandon a longstanding preference for weaker exchange rates.

The new dynamic marks a departure from the period of low inflation that followed the 2007-09 global financial crisis, when historically low interest rates and large-scale asset purchases — which were partly aimed at boosting growth through a weaker currency — sparked accusations that some economic policymakers were pursuing a currency war.

But in the global burst of price growth that has followed the coronavirus pandemic, stoked even further by Russia’s invasion of Ukraine, the focus for central banks has shifted from encouraging growth to bringing down inflation. “We are now in a world where having a stronger currency and offsetting the forces driving inflation is something that policymakers actually welcome,

The term “currency wars” was originally a colorful description of what international economists had long called “competitive devaluations” or, after exchange rates began to float in the early 1970s, “competitive depreciations.” In these situations, countries feel aggrieved that their trading partners are deliberately pursuing policies to weaken their own currencies in order to gain an unfair advantage in international trade. Competitive depreciation can arise when all countries’ main macroeconomic goals, in addition to maximizing GDP growth and employment, include improving their trade balances. This generally describes the past few decades in the world economy.

A reverse currency war, on the other hand, involves competitive appreciation. Here, countries think their trading partners are deliberately trying to strengthen their currencies in order to rein in inflation. This could describe the period that began in 2021, when inflation returned as a serious problem in most countries.

In both cases, it is impossible for all countries to pursue such strategies, because they cannot all move their exchange rates in the same direction at the same time. Both competitive depreciation and competitive appreciation are often perceived as evidence of a lack of international cooperation to achieve exchange-rate stability, and sometimes lead to calls for a new Bretton Woods-type arrangement to promote greater policy coordination.

CA Harshad Shah,

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