Conflicts are arising in regard to global monetary policy as the recovery attempts of distressed economies could erupt in a global currency war.

What Is a Currency War?

A ‘currency war,’ as it has been called, is the battle between countries to control their economies through manipulation of their currencies.

When the value of a country’s currency drops, it becomes cheaper for foreign countries to buy goods from this country. Because of a devalued currency, the country experiences an increase in exports, which leads to an increase in production and economic growth. Also, the country experiences a decrease in imports due to reduced buying power. Essentially, there is a positive flow of money.

As a result, foreign countries could experience the opposite of what this country experiences. In times when the global economy is in trouble, devaluing the currency of one economy could jeopardize the growth of another.

U.S. vs. China

The recent dispute between the U.S. and China over currency policy involves competing strategies to manipulate their ailing economies.

The U.S. has kept interest rates near zero to spur lending but it has yet to stimulate substantial economic growth. The Federal Reserve is considering the implementation of the second phase of quantitative easing, which essentially would be “printing money” and reducing the value of the dollar (USD).

China has tried to stave off a property market bubble that is threatening its quick economic expansion. Despite being pressured by the U.S. and other countries to allow its currency to appreciate to reflect its true economic value, China has refused these demands until it feels such a step would be beneficial.

In addition to having the two largest economies in the world, U.S. and China are also high-volume trade partners. Changes in the value of currency could disrupt the trade relationships between the two countries. The U.S. wants to stimulate its economy by devaluing its currency while China wants to achieve sustainable growth by suppressing its currency’s value.

Both countries want a competitive advantage in exports through a weaker currency. As each country employs strategic monetary policy to maintain a weaker currency, they are engaging in a currency war.

The U.S. and China are two of the economic superpowers that are trying to use fiscal policy to advance their economies, but similar situations are evident in many other countries around the world. This could possibly result in a global currency war.

Coverage of the currency war, courtesy PBS NEWSHOUR, featuring Business and Economics Correspondent Paul Solman:

Upcoming Fed Meeting

The Fed meetings on Nov. 2 and Nov. 3 on monetary policy could reveal whether America will proceed with the next step of quantitative easing. The details on exactly how much money will be created (estimated $500 billion) and in what time frame remains unknown. If quantitative easing has its intended effects, the weakening dollar would represent another ‘attack’ in the currency war.

UPDATE: The U.S. Federal Reserve chose November 3 to enact quantitative easing by buying $600 billion in bonds.

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