Currency Wars: Exchange Intervention in a Floating World
by Brienne Thomson

[March 2012, Transcript] - As an interdependent global economic web, we are mutually dependent on one another's imports, exports, fiscal and monetary stability. Imbalances and bad investments that culminated to a tipping point in 2008, set off a domino effect of instability and currency fluctuation. [2] Now, while countries fight to combat the economic aftermath of account deficits and overvaluation, many have begun launching “competitive devaluation” tactics by using their currency as a weapon to expedite their economic growth. [3]

Now, although this is a pretty clear cut description of the current state of our global economy, it sounds probably just as convoluted as our “economic web” has come to be. In simpler terms, our interdependency and the current economic instability has put countries on the defensive. They’re trying to save themselves without regard to their trading partners and they’re using their currency as a shield … or in some cases, a sword.

Now, although this is a pretty clear cut description of the current state of our global economy, it sounds probably just as convoluted as our “economic web” has come to be. In simpler terms, our interdependency and the current economic instability has put countries on the defensive. They’re trying to save themselves without regard to their trading partners and they’re using their currency as a shield … or in some cases, a sword.

First, I’m going to bring up three “currency war” cases that emerged in 2010, but I also want to emphasize the notion of persistent account imbalances that I will clarify later, as the root cause of the crisis we’re suffering today.

The Brazilian Real – Brazil’s economy is booming. With high interest rates, they’ve seen tremendous foreign capital investment. And with the high value of the real, imports to Brazil have skyrocketed. Brazilians are off traveling and spending money abroad. But the real isn’t just experiencing a “high” value. It’s experiencing overvaluation, which has the potential to implode. [8]

The Swiss Franc – With the struggling euro, EU investors have been looking to the Swiss franc as a safe investment. Like Brazil, this influx of investment has over-stimulated the Swiss economy, putting it in an economic imbalance. [14]

The Chinese Renminbi – Unlike the Brazilian real and Swiss franc the Chinese renminbi is a fixed currency; and in today’s economy it’s being held for safety. What’s interesting is that, as opposed to the real and franc that float freely and automatically adjust with the economy, the renminbi is being purposely held at a lower rate. It is undervalued, and thus causing its trading partners, specifically "US," to accuse China of artificial currency manipulation. But, why would we complain if our Chinese imports are cheaper? [10]

So, here we have two cases of overvalued “floating” currency and one case of an “undervalued” fixed currency. But in order to understand how these currencies reached these “threatening” points, I’m going to explain the economic bits and pieces that created this tension.

So How is Currency Valued?
First off, the demand for a country’s currency is based on their Balance of Payments, which is essentially their account balance after adding their Current and Capital Accounts. Generally, a country’s balance, which is just like a credit report, will dictate whether or not they’re a safe investment. This, coupled with the return on investment, or interest rate, dictates whether or not they’re a profitable investment.

So, the Balance of Payments (BOP) = the Current Account + the Capital Account.

A country’s Current Account records goods, services and transfers between one country and the rest of the world; like raw materials, merchandise, tourism, royalties, and investment earnings. Money owed to foreign countries are debts and money owed by foreign countries are credits. Together the debts plus the credits equal the current account balance. [1, 6]

What the Current Account is missing is all of the financial transactions between one country and the rest of the world, which is where the Capital Account comes into play. The purchase of foreign bonds, land, currency or businesses is capital outflow. The purchase of domestic bonds, land, currency or businesses by foreign sources is capital inflow. [1, 6]

Thus, as it’s been with the United States since 1991, a country can only have a Current Account deficit, meaning it spent more than it earned, if it has a Capital Account surplus, meaning that other countries lend it enough money to pay off its deficits. Or the inverse; a Capital Account deficit = a Current Account surplus, meaning a country’s income is greater than its expenditures, and its savings has been lent to countries with deficits. [6]

Either way, whichever side the deficit or surplus is on, Current or Capital, the accounts are “supposed to” add up to zero; emphasis on “supposed to.” According to International Monetary Fund reports there is currently a negative discrepancy between Capital and Current accounts that it blames on misreporting and lag-time. [7] And, to add to this "disappearing money," the Encyclopedia of Economics notes that the world ran a current account deficit averaging more than $95 billion annually during 1995–2003, which is about the entire GDP of Morocco or Pakistan; missing! [5]

So, depending on whether a county’s Balance of Payments is in deficit or surplus, signifies the strength of that country’s economy, currency and interest rates.

Interest Rates
Interest rates are raised by central banks to attenuate inflation – this is done to promote foreign investment and grow the value of a currency. Rates are lowered to promote borrowing and thus spending, which both stimulates the economy
and promotes exports, but also devalues the currency.

Key point: interest rates play a pivotal role in the value of currency, since they are the biggest driving force behind the demand of a country’s currency.

•    High interest rates = a high return on investment for a lender with, of course, a decrease in borrowing and spending. When the value of the dollar is low, which = a high price level (the ability to buy less per dollar), people don’t invest, which drives up interest rates.
(←SHORT RUN ║ LONG RUN→) High interest rates and high exchange rates entice foreign investors, decreasing the supply of dollars on the foreign exchange market and thus, increasing the value of the dollar; expensive money = uncompetitive exports. [7A]

•    Low interest rates = a low return on investment for a lender with, of course, an increase in borrowing and spending. When the value of the dollar is high, which = a low price level (the ability to buy more per dollar), people invest, which drives down interest rates. (←SHORT RUN ║ LONG RUN→) In seeking higher returns, investors go abroad to take advantage of low exchange rates, increasing the supply of dollars in the foreign exchange market and thus, decreasing the value of the dollar; cheap money = competitive exports.

So, to bring this back to our example of the Swiss franc and Brazilian real – in a global recession, profitable investments are limited. Switzerland, as a longstanding euro-central bubble of monetary solidarity, and Brazil, as a burgeoning beanstalk with high interest rates, have been flooded with crisis-prompted foreign investments.

These types of massive investments of buying and selling currencies on the foreign exchange market, or Forex, are the cause of the up-and-down valuation ticks of foreign currency. The more of a currency purchased, the less available on the market, which causes a higher value – extreme cases, like the franc and real buying frenzies have caused overvaluation.

When a currency is overvalued, its exports become too expensive to trade, which results in a trade deficit; more imports than exports. This overvaluation threatens to cause even slower growth of the Swiss and Brazilian economies in the midst of a global recession, if preventative monetary policies aren’t enacted.

“The Brazilian real in recent days, has appreciated to about 1.70 real to the dollar, a 9% gain so far in 2012,” reported The Wall Street Journal. “The stronger real hurts Brazilian exporters and manufacturers.” [9]

In Switzerland, the franc was reported to be more than 40-percent overvalued compared to both the dollar and euro, according to the Organization for Economic Cooperation and Development.

To sum up the Swiss and Brazilian overvaluation crisis, if their governments don’t do something to devalue their currencies, they will spend their way into an economic collapse by essentially losing all customers.

On the other extreme is China. And I want to emphasize “extreme” here because it is only extremes that drive countries to currency wars, from the Great Depression of the 1930s to the Asian Financial Crisis of the late 90s. The controversial point here is that China’s renminbi is undervalued.

If an overvalued currency causes goods and services to be too expensive to export, an undervalued currency would cause exports to be cheap. Now, why would this anger the big economic ringleaders with all their “MADE IN CHINA” imports, which is mainly "US" as well as China’s biggest importer, the 27-country strong European Union?

Well, with Chinese goods so cheap, there is no incentive to buy domestic products. As Americans and many other countries gobble up Chinese goods, we are simultaneously pulling money out of our economies and injecting it into China, leaving China with a huge trade surplus – a $27.2 billion US dollar surplus as of January 2012 to be exact. [11]

Basically, the devalued renminbi, held tightly by the Chinese government at its low level, is China’s “weapon” against the recession. As a result, China has been accused of exacerbating slow economic growth by "US" and competing exporters internationally.

Now, how can China “hold” their currency at a specific rate?

Unlike the Swiss, Brazilian and U.S. currencies that float freely in accordance with the ebb and flow of the market, China’s currency is under tighter control. The renminbi was pegged to the US dollar up until 2005, when it was released and re-pegged to a basket of currencies; the dollar, euro, yen and Korean won. However, from the currency rates within this basket, it was allowed only a very narrow margin of fluctuation. The renminbi did see a 21-percent appreciation from 2005 through July of 2008, when it was again pegged to the flagging U.S. dollar to shield itself and its growth from the international recession. [13]

Thus, between our depreciating dollar and China’s thriving economy, the renminbi was held practically stagnant and gravely undervalued until 2010, when the Chinese government loosened its clinch on the renminbi to satisfy pressure from abroad. According to the New York Times, as of February 2012, however, it is still “undervalued relative to all other currencies, by 5 to 20 percent.” [11, 13] 

So, is it fair to have both fixed and floating currencies competing in our global economy?

Well, actually Fixed Exchange Rates and Floating Exchange Rates are trade-offs.

According Thomas Oatley, the author of International Political Economy, “The international monetary system requires governments to choose between currency stability and national economic autonomy.” [4]

What Oatley is referring to is that with a floating exchange rate a country is completely dependent on the market to dictate its currency’s value, but has the freedom to impose monetary policy to manipulate it. Whereas, a country with a fixed exchange rate has its currency pegged to the value of a stronger currency to ensure greater stability. But, as a result, it doesn’t have the autonomy to institute monetary policy to modify the value of its currency to deal with other internal economic issues.

How is the Value of Currency Regulated?

These systems of currency valuation, but more specifically the lack of regulation of how currencies are manipulated and valued, is in great debate … and should be.

Initially, regulating authorities were established after WWII when a modified method of the gold standard was implemented. In 1944 the world fixed their currencies to the U.S. dollar and the U.S. government fixed the dollar to gold. Thus, the U.S. dollar became the foundation or “reserve currency” of the international community. The International Monetary Fund (IMF) was created to monitor exchange rates and lend “reserve currencies” to nations with trade deficits. The World Bank was also instituted to provide loans to help foster underdeveloped nations.

By 1971, however, inflation, fluctuations in the price of gold and low reserves forced the U.S. to abandon the established “fix” with gold, and float. Other developed countries jumped on the boat, while less developed nations maintained hold to their anchor on the U.S. dollar.

“The dollar retained its position as the world’s reserve currency, but now it was backed not by gold, but only by trust and the fact that oil and other commodities were traded around the world in dollars.” [3A]

As the world’s currency provider, the U.S. must retain a current account deficit as the FED continues to print, inflate and distribute dollars around the globe. A resolution to this grave imbalance and instability of the U.S. dollar has been vocalized by economists around the world. Keynes was right, they say.

As economist John Maynard Keynes advised in 1944, when he objected to the U.S. dollar being appointed the international reserve, a regulated world currency would be more secure and endure.

Brazil, Switzerland & China React
So, with the ability to manipulate monetary policy, which is money supply and interest rates, and fiscal policy, which is taxation and spending, what have Switzerland and Brazil done to deflate their overvalued currency?

Brazil has boldly imposed taxes on foreign investment inflows to prevent or slow investors from buying up the value of the real and basking in Brazil’s 10.5-percent interest rate – as compared to the .25-percent rate in the U.S. as of January 2012, for example. But according to Guido Mantega, Brazil’s Finance Minister, a trading floor will not be imposed on the real.
[9, 11]

In a more extreme defense to weaken the franc, in September of 2011 the Swiss National Bank took hold of its floating exchange rate and set a floor to “fix” it against the euro. The franc had appreciated greatly, to be nearly on par with the value of the euro. So, to shield their economy, the Swiss grounded it at 1.20 francs to the euro. [14] On top of pegging their currency, the SNB also cut its main interest rate to zero. [11]

And how has China responded to international pressure to “equalize” the value of the renminbi?

When the undervaluation of the renminbi hit the headlines at the beginning of 2010 it was undervalued by 25-percent. With international pressure and accusations of currency manipulation, the Chinese let the renminbi appreciate to where it is today; still undervalued, but now by 10-percent. It is currently worth about 16-cents on the U.S. dollar.

With goals of economic development and modernization, China is following the path of other industrialized nations, specifically "US," who grew to power based on exports. As the third largest economy in the world and the single biggest foreign holder of U.S. government debt, China however, has no obligations to bend any further. [12] 

ENDuring Dilemma
A major fear of these currency wars is policy retaliation and countries working against one another, as though their currency and economy exist in an isolated bubble. And, that the acknowledgment that we are, more than ever, dependent on one another to grow and thrive is “foreign” … for lack of a better term.

Aggressive and malicious currency devaluation during global recessions disrupts the allocation of scarce resources and slows the growth of other countries – who are both competitors and clients in this globalized economy. Additionally, in the case of China, other issues, like intellectual-property theft and barriers to entering Chinese markets are adding to the drag on economic growth. [13]

Of course, defending one’s currency from overvaluation through policy is necessary. But as the Finance Minister of the world’s seventh largest economy, Brazil, upheld, coordination of economic policies and the promotion of greater
international growth, can be more beneficial for the “whole world” that we are.

And while this cooperation in our global economy is vital, consensus among international economic players has proven to be almost impossible. So, as currency wars wage on within our obfuscated economic system, we remain without a central organization to regulate and enforce rules.

This ongoing chaos makes the proposal for one global currency sound as though it may be a fair remedy for today’s unregulated currency manipulation. However, some argue that a global currency will hurt democratic freedoms. [6A] Andrew Marshall from the Centre for Research on Globalization wrote that “the very concept of a global currency and global central bank is authoritarian in its very nature, as it removes any vestiges of oversight and accountability away from the people of the world, and toward a small, increasingly interconnected group of international elites.”

Thus, while unifying on the foundation of a single currency might stabilize us as a whole, it’s getting there and agreeing on regulations in a fair and efficient manner that is the incessant battle.


General Economics
[1] “Capital Account, Current Account.” ValueClick, Inc. June 1999. Online Dictionary. 28 Feb. 2012 <>.

[2] Corden, Max. “Global Imbalances and the Paradox of Thrift.” Center for Economic Policy Research. 11 April 2011. Online Article. 28 Feb. 2012 <>.

[3] Hotten, Russell. “Currency Wars Threaten Global Economic Recovery.” BBC News. BBC. 6 Oct. 2010. Online Article. 28 Feb. 2012 <>.

[3A] Newman, Alex. "Waking up to a World Currency." The New American. 15 Sept. 2010. Online Article. 6 March 2012 <>

[4] Oatley, Thomas. International Political Economy: Interests and Institutions in the Global Economy. 3rd ed. New York: Longman, 2008: 216 <>.

[5] Ott, Mack “International Capital Flows.” The Library of Economics and Liberty. Liberty Fund, Inc. n.d. Online Article. 28 Feb. 2012 <>.

[6] Reff, Steven and Dick Brunelle. Balance of Payments Interactive. Reffonomics. Thomas R. Brown Foundation. 2008. Web. 28 Feb. 2012 <>.

[6A] Marshall, Andrew. "A Global Central Bank, Global Currency & World Government." New Dawn Magazine. Aug. 2009. Online Article. 17 March 2012 <>

[7] “World Economic Outlook (WEO).” 20, Sept. 2011. Web. 29 Feb. 2012 <>.

[7A] Mankiw, N. Gregory. Principles of Economics. 6th ed. Mason: South-Western, Cengage Learning, 2012, Print.

[8] Lim, Richard. "Brazil’s Currency Wars – A ‘Real’ Problem." Sounds and Colours. 11 Oct. 2010. Online Article. 28 Feb. 2012 <>.

[9] Murphy, Tom and Lunciana Magalhaes. "Brazil Minister Says Global Currency War Is Intensifying." The Wall Street Journal. 23 Feb. 2012. Online Article. 1 March 2012 <>.

[10] Barboza, David. “Currency Fight With China Divides U.S. Business.” The New York Times Company. 16 Nov. 2010. Online Article. 28 Feb. 2012 <>.

[11] "China Balance of Trade." “Switzerland Interest Rate.” “Brazil Interest Rate.”
“U.S. Interest Rate.” Trading Economics. Jan. 2012. Online Econ Data. 29 Feb. 2012. <>.

[12] Kroeber, Arthur R. “China's Currency Policy Explained.” The Brookings Institution. 7, Sept. 2011. Online Article. 1 March 2012 <>.

[13] "Renminbi (Yuan)" The New York Times Company. Feb. 16, 2012. Times Topics Online. 29 Feb. 2012 <>.

Video Graphic:
Kritzer, Adam. "Archive for the 'Chinese Yuan (RMB)' Category" 2, June 2011. RMB Valuation Table 2004-2011. 1 March 2012>.

[14] Evans-Pritchard, Ambrose. “Switzerland Abandons Floating Exchange Rate in Dramatic 'Currency War' Twist.” The Telegraph. Telegraph Media Group Limited. 6 Sep 2011. Online Article. 28 Feb. 2012 <>.


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