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Currency wars conjure images of trade wars

Michael Collins  |  03 Dec 2012Text size  Decrease  Increase  |  

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Michael Collins is an investment commentator at Fidelity Worldwide Investment, a global asset manager.


The Great Depression became great, in part, because it featured a trade war. The so-called Great Recession since 2008 has so far escaped the same disaster.

Instead, it is hosting a so-called central bank currency war that could damage many countries, including Australia. But there's a difference between a trade war and currency war that makes the latter less venomous at a global level.

The trade war of the 1930s was kicked off by the US Tariff Act of 1930, which is better known as the Smoot-Hawley Tariff after its sponsors.

President Herbert Hoover approved the bill, which imposed record high tariffs on more than 20,000 goods, to protect US farmers from imports. US trading partners retaliated and world trade plunged by about two-thirds from 1929 to 1934, when measures were taken to reduce slugs on imports.

Not only did the tariff war wreck global trade, it thwarted collaboration between countries to fight the global economic slump. The General Agreement on Tariffs and Trade signed in 1948, which was a precursor to the World Trade Organisation, was designed to prevent a repeat of this self-destructive behaviour.

The start of today's currency war is harder to pin down. It certainly gained speed on 6 September last year when the central Swiss National Bank unexpectedly said it would "with the utmost determination" purchase "unlimited quantities" of foreign currencies to block the Swiss franc's rise against the euro, the currency of most of its trading partners.

Up to that day over 2011, the Swiss franc had jumped 13 per cent against the euro as doubts mounted that the single currency would survive the eurozone's financial crisis.

China, Brazil and other developing countries would date the currency war to no later than August 2010, when the Federal Reserve flagged its second round of quantitative easing.

Although the premise is unproven, many - especially forex dealers - think central-bank-financed asset buying creates inflation, which in theory lowers a country's exchange rate.

Guido Mantega, Brazil's finance minister, immediately used the term "currency war" to describe the results of the Fed's asset buying. By November of that year, Beijing berated Washington for risking a "currency war" by adopting "self-serving macro-policies".

The Fed's quantitative easing, since it aims to promote consumption and investment by lowering interest rates, encourages more imports to the US as much as it might aid exports through a lower currency.