The Keepers of the Currencies: Central Banks and the “Currency Wars”


One interpretation of recent US monetary policy. Image: Todd Benson, flickrIn spite of the national myths surrounding the virtues of a “strong currency”, great currencies like the US Dollar, the Pound Sterling and the Japanese Yen are falling in value. While the natural course of the 2007-08 economic crisis in these nations can certainly be blamed, eroding the value of currency has become a conscious decision by policy makers in central banks and is embraced by these countries’ governments. Alarmed emerging economies have accused these advanced countries of waging a covert currency war behind the veils of “quantitative easing” and “monetary stimulus.” Currency matters were even the subject of a recent G20 summit. But rather than a return to the destructive beggar-thy-neighbour currency policies of the 1930s, the new currency “wars” reflect the growing power of central banks and the changing ways in which they manage the economy.

In the wake of the financial crisis, central banks were catapulted to the frontlines of the battle against the economic downturn. Since the early 90s, central banks had been the independent technocratic stewards of monetary policy, free from political interference and dedicated to the single goal of maintaining price stability. But now they have been thrust evermore into the spotlight: With national governments obsessing over debt and punishing their economies with austerity policies, it has fallen to central banks to stimulate the economy.

In this they have performed admirably, and the crisis would most certainly have been worse without the interventions of central banks. However, central bank leaders such as Federal Reserve chairman Ben Bernanke are still unsatisfied with the progress of the economy, particularly with sluggish growth and lingering unemployment. They insist they will continue to pump money into the economy.

But how do the measures being implemented by central banks give way to accusations of currency wars? This has, in part, to do with the severity of the crisis. Traditionally, central banks have managed the economy by altering the short-term interest rate, but these days interest rates have already been lowered so much that they can’t be cut any further to give more stimulus to the economy. The famed “quantitative easing” (QE) has been heralded as a solution. Here, a central bank purchases vast swathes of government bonds to increase the money supply. But this, in turn, also lowers long-term interest rates.

Faced with an environment of low interest rates, and hence lower returns, investors channel their money elsewhere, for example, from the US or UK to emerging, higher growth countries like Brazil. These “hot money” flows cause the currency of the sending country to depreciate and the currency of the receiving country to appreciate. Indeed, it is Brazil, whose currency has appreciated thanks to money inflows, which has protested the loudest about currency wars. QE is seen as a trick used by advanced economies to deliberately lower the value of their currencies to increase exports at the expense of the growing emerging economies. But the record for the advanced economies is so far mixed, with Japan succeeding in boosting exports while the UK is continuing to struggle.

Central banks injecting more money into the economy brings a variety of consequences. Image: on flickrWhile drawing flack from emerging economies, central banks have been praised by others for their unorthodox monetary measures. Rather than a deliberate ploy to undercut developing countries, currency depreciation in advanced economies can be regarded as just a by-product of the exceptional economic difficulties being faced. It has, for example, been argued that a weak pound is just a reflection of the weakness of the British economy. Elsewhere it is maintained that the growth-friendly nature of more monetary easing in advanced countries helps the world economy as a whole. If growth returns in rich countries like the US, it will lead to more imports from emerging economies later, it is claimed.

But increased “easing” risks igniting inflation, the very adversary central banks were granted their independence to contain. Inflation targeting has been the macroeconomic policy gospel of recent decades. Central banks are legally obliged to keep inflation at a target rate, but this is likely to change. For example, the Bank of England has repeatedly missed its inflation target, and the UK government has allowed it to “review” its inflation goals. In Japan, recently anointed Prime Minister Abe has pressured the Bank of Japan to increase its inflation target, giving more precedence to stimulating growth rather than maintaining stable prices.

If the central banks start to tolerate higher inflation, they are in effect lowering real interest rates even further, turning them negative if inflation outpaces interest earnings. This suits governments which are saddled with high debts and need to keep issuing bonds to finance public expenditure, but it also erodes the value of savings. Artificially directing lending towards governments in this way bears the menacing name “financial repression”, and it is often seen to signify a tighter relationship between government, central banks and the financial system.

The hallmarks of best practice in central banking have, for decades, been independence from governments and inflation control, but there are now signs that this is changing. Complaints about “currency wars” are, in reality, just one reflection of the growing power of central banks. Financial repression, or perhaps even a return to economic stability in times ahead, might be its future consequences.


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