Currency War and Peace

WASHINGTON, DC – Much of the hype surrounding last month’s meeting in Moscow of G-20 finance ministers and central bankers was dedicated to so-called “currency wars,” which some developing-country officials have accused advanced countries of waging by pursuing unconventional monetary policies. But another crucial issue – that of long-term investment financing – was largely neglected, even though the endgame for unconventional monetary policy will require the revitalization or creation of new long-term assets and liabilities in the global economy.

The collapse of Lehman Brothers in 2008 drove up risk premia and triggered panic in financial markets, weakening assets in the United States and elsewhere, and threatening to provoke a credit crunch. In order to avoid asset fire-sales – which would have led to the disorderly unraveling of private-sector balance sheets, possibly triggering a new “Great Depression” or even bringing down the eurozone – advanced countries’ central banks began to purchase risky assets and increase lending to financial institutions, thus expanding the money supply.

While fears of meltdown have dissipated, these policies have been maintained or extended, with policymakers citing the fragility of the ongoing economic recovery and the absence of other, equally strong policy levers – such as fiscal policy or structural reforms – that could replace monetary policy quickly enough.

But several years of ultra-loose monetary policy in the advanced countries has led to significant liquidity spillover abroad, putting excessive upward pressure on higher-yielding developing countries’ currencies. With developing countries finding it difficult to deter massive capital inflows or mitigate the effects – owing to economic constraints, like high inflation, or to domestic politics – the “currency wars” metaphor, coined in 2010 by Brazil’s finance minister, Guido Mantega, has resonated widely.