The best remembered frenzy of competitive devaluations in history came during the Great Depression, as countries were in an unseemly hurry to abandon the gold standard. Until its collapse in 1971, the Bretton Woods system prevented a repeat of such tit-for-tat strategies by linking the value of many currencies to the dollar.
The race to the bottom has simmered for years as countries fought their way out of the recession triggered by the 2008 financial crisis. In 2010, Brazilian Finance Minister Guido Mantega gave the name to the race to the bottom a currency wars. His country had been an early casualty in the war, after lower U.S. rates sent money flowing into emerging markets, making Brazil’s commodity exports more expensive. A big winner at the times was Japan, as the yen lost a third of its value against the dollar from the start of 2012 to the end of 2014, propelling profits for corporate Japan.
Over the last decade, China has held down the value of the yuan helping transform the country into an exporting powerhouse. After China’s surprise devaluation in August 2015 there was a further slide in the currency in early 2016. The market felt that China would depreciate the yuan more to revive a slowing economy. Japan surprised the markets by introducing negative interest rates, following the European Central Bank’s move below zero in 2014. In all 24 countries cut interest rates last year, many surprisingly. Big market shocks came from Canada to Singapore as they unexpectedly eased. The U.S., Japan and Europe used bond-buying plans in addition to rate cuts to stimulate their economies. As the recovery limped along, central bankers eased policy further to ward off deflation, or a drop in prices that can cripple spending and sap growth.
Who is getting hurt?
Mainly the U.S., where the first interest rate increase in almost a decade pushed the dollar higher against all 16 of its major peers in 2015. The G-20 countries again and again pledge to resist competitive currency devaluations, though it has stopped short of criticizing any particular country for doing so. Meanwhile, U.S. exporters have been feeling the pain, putting the recovery at risk. The US’s inertia in economic recovery is increasing the temptation to weaken and accelerate the race to the bottom. But what will the find when they get there?