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Fears of a currency war have piled atop anxiety about rising tariffs and their toll on the global economy.
Stock markets around the world swooned after Beijing allowed its currency to fall below a key level against the U.S. dollar. The United States declared China a currency manipulator. Meanwhile, the U.S. and other nations have shifted toward lowering interest rates – a move that can often result in weakening currencies.
But is this a currency war, a modern version of what happened during the Great Depression when nations devalued their currency in a vain attempt to boost their exports at the expense of others?
Many economists are skeptical. The big risk to global economic growth, they say, isn’t currency but tariffs – with the U.S. threats escalating against China last week. And the interest rate cuts can be explained as addressing that risk to overall growth, not as currency manipulation.
Pushing currency values lower can also blunt the impact of tariffs. Battles over currency “are not that bad,” says Olivier Jeanne, a senior fellow at the Peterson Institute for International Economics in Washington. But as a tool in a rising trade war, it’s worrying.
A new front opened this week in America’s ongoing standoff with China over trade. Instead of tariffs, this battle is over the value of currencies.
After Beijing allowed its currency to fall below a key level against the U.S. dollar, stock markets swooned around the globe. The United States declared China a currency manipulator, and nations began looking at cutting interest rates, following the Federal Reserve’s move last week.
Is this a currency war, a modern version of what happened during the Great Depression, when nations devalued their currency in a vain and desperate attempt to boost their exports at the expense of others?
Opinion is divided. Some economists say there’s little evidence of one. Others say we’ve been in a currency war for nearly a decade. What they do agree on is that fears of damage from a currency war are likely overblown.
“The trade war is much worse,” in terms of creating economic damage, says Jeffrey Frankel, an economist and Harvard professor.
“We are in a new phase of the currency war,” says Olivier Jeanne, senior fellow at the Peterson Institute for International Economics in Washington. “But overall, [such wars] are not that bad.”
Sometimes, they can lead to positive outcomes.
Lessons from the 1930s
This represents a significant shift in economic thought, which had long blamed the competitive devaluations of the 1930s as prolonging the Great Depression. In the past three decades, many economists have swung to the view that such policies helped depreciate currencies relative to gold and allowed nations to keep interest rates low and expand their money supply, which was badly needed to battle the deflation of the time.
When trade tensions rise, tariffs and currency often play off each other in intriguing ways. Think of a seesaw.
If a country wants to boost its exports, it can push down the value of its currency, which will make its traded goods less expensive. It can do this in various ways directly, such as printing more money, or indirectly, by lowering interest rates. Lower interest rates can make the currency less attractive to investors, so they sell it and buy other currencies that offer a higher return.
But nations also lower interest rates for other reasons, often if their economy slows. Lower rates can help boost growth by making it cheaper for businesses and consumers to borrow money. So when a nation lowers its interest rate, is it doing so to prop up its economy or sell more abroad?
“The line is very difficult to draw,” says Robert Staiger, a professor of economics at Dartmouth College.
In 2010, as the Federal Reserve and other central banks used unconventional means to respond to the financial crisis, Brazilian Finance Minister Guido Mantega popularized the term “currency war” to describe the destructive impact their actions were having on his economy.
On Monday, when China allowed its currency to weaken, moving to more than 7 yuan per dollar for the first time in a decade, the Trump administration promptly labeled Beijing a “currency manipulator.”
But in the face of its slowing economy, caused in part by U.S. tariffs, many finance experts say it would make sense for China to lower the value of its currency. Last week, the Federal Reserve also lowered rates, saying it was acting in part to offset the risks of a trade war dragging down growth.
Other central banks are following the Fed’s lead. The European Central Bank is talking about reducing interest rates. India, New Zealand, and Thailand cut rates Wednesday. Are they all manipulators in a big currency war – or simply trying to stabilize their economies as prospects for global growth fade?
Either way, a defining feature of this moment is President Donald Trump’s aggressive use of tariffs in an attempt to force China to change policies.
Devaluation as a “subsidy” for U.S. consumers
The president’s tariffs have imposed, by one estimate, a $72 billion tax on American consumers, in the form of higher prices. But as Trump advisers have pointed out repeatedly in recent days, the prices of most goods haven’t risen much, if at all, and inflation remains tame. Why?
Back to the seesaw. A big reason is the depreciation of China’s currency, which has largely offset the tariffs. This kind of depreciation naturally happens when tariffs are imposed, economists say.
That Chinese “subsidy” is good for U.S. consumers, but it poses a problem for China. Its exporters are not seeing much gain from depreciation, while its importers are seeing their spending power shrink. That’s an economic drag on the nation, which is the world’s largest importer of oil and holds an estimated $800 billion in dollar-denominated debt. It also likely serves to restrain how much Beijing is willing to devalue its currency, just as Mr. Trump reportedly has shot down ideas of depreciating the dollar.
The Trump administration’s hope is that new U.S. tariffs would be such a knockout blow to a slowing economy with a shaky debt picture that Beijing will blink. “The Chinese economy is crumbling,” White House economic adviser Larry Kudlow told CNBC Tuesday. “It’s just not the powerhouse it was 20 years ago.”
For all their public bravado, both sides have an interest in bridging their differences sooner rather than later. A trade agreement, which seems remote right now, is not unthinkable.
Little hint of compromise
But economists are skeptical. With some $3 trillion in reserves and strong control over the economy, China may well weather a new tariff storm without dipping into recession. And even if it does, “it’s not going to lead the Chinese to give in to U.S. demands,” says Mr. Jeanne of the Peterson Institute, based on his reading of Chinese economists at a recent meeting.
The changes the U.S. is asking China to make are just too big, trade experts say.
Unfortunately, the interplay between tariffs and currency may cause problems this time around. A day after the Fed reduced interest rates, in part because of the uncertainty surrounding trade policy, Mr. Trump tweeted that he would impose tariffs on the remaining $300 billion of Chinese imports on Sept. 1 unless there was progress in talks. Is the Fed’s easing giving the president leeway to push his case more aggressively?
“The central bank is giving politicians the impression that if they screw up on trade policy, they [the bankers] can undo the damage,” says Mr. Frankel of Harvard. “That’s why I do worry about the ‘currency war.’ It’s not because of what will happen to exchange rates. ... [But] you’re aiding and abetting the bad trade policy.”