Currency War - Affecting Global recovery

Over the past decade, the world has been divided into "deficit" countries and "surplus" countries.

This has led to tensions. The US says it wants to export more, to help its economy recover. But the surplus countries like China don't want their exporters to lose their competitive advantage.
      The quickest way to gain a competitive advantage is through a weaker currency.
A very good piece of paper has been taken from economic times to grasp the ongoing conflict regarding currencies of countries-how they are using their currencies to boost their export and economy.
America and other developed countries has blamed China for devaluating its yuan to protect its exports.

What is currency war ?
The term ‘currency war’ was used in recent times by Brazil’s finance minister Guido Mantega in the first week of October this year reacting to China’s attempt to protect the yuan from rising too quickly against the dollar. It comprises competitive measures by governments to improve their trade by maneuvering exchange rates. A cheap currency, vis-à-vis the dollar, adds to the competitive advantage to the exporter. Countries such as China, Brazil, South Korea and Japan have taken measures to devaluate their currencies which would help them boost exports and create jobs.
An attempt by the government to prevent its currency from appreciating too steeply and too fast against competing nation is what is seen as currency war between different countries. The history of currency wars dates back to the Great Depression era when major economies devalued their currencies as a part of a measure to give preference to local goods over imported ones.

(The People's Bank of China has bought up trillions of dollars in order to keep its currency weak against the dollar. As it helps keep Chinese exports artificially cheap. US seems not happy with this move. This is affecting recovery of developed countries like US)

Its impact on Indian economy
When competitors devalue their respective currencies, domestic exporters tend to lose out on the price advantage on their exportables as buyers prefer to buy from a cheaper currency. This in turn hurts income as well as the jobs in the export sector and the prospects for the economy.
    The central bank at such times tries to intervene — buy dollars and create an artificial demand for the dollar, devaluing the value of the rupee in the process and retain some price advantage for the exporter. But buying dollars involves a fiscal cost as the central bank has to pump in equivalent amount of rupees and again mop it up by selling bonds. These bonds need to be serviced by the government. This would in turn worsen the fiscal position.

How does currency war impact global recovery?
Currency wars are a part of what is described as a ‘beggar thy neighbour’ policy — attempts by a country to solve its economic problems by causing worse difficulties in other markets. When all countries engage in such policies, it turns out to be a race to the bottom. As countries compete to devalue their currencies to save the interest of their exporters, it collectively reduces demand for foreign goods, something that world economies cannot afford at a time when the process of global recovery from the after affects of the crisis of 2008-09 is still underway. Also, competitive currency devaluation is happening at a time, when some of the developed economies have a soft money situation, wherein monetary regulators are on a quantitative easing spree, lowering their interest rates, which is making emerging economies trying to regulate their inflation an arduous task, as direction of the capital flows has turned towards them. There is also the fear of a bubble, which will burst once developed economies are back on track and the flow of capital shrinks. This shrinking is expected to be first reflected in the currency markets.

The current international thinking on the matter?
The United States is looking for global support at forums such as the G20 to the IMF, so that there can be collective pressure on China to ease up on the Yuan. IMF feels that it is the right place to make progress on the currency question . Emerging nations are not very keen to range themselves in this battle. Finance minister Pranab Mukherjee has said he urged countries to work towards a consensus as the way forward.

What can be done to prevent this trend?
All this leaves one big question - what can countries like the US and UK do to reduce their deficits?

One option is austerity. Consumers and companies are already cutting back on borrowing. If governments do the same, the entire country borrows less, and its deficit reduces.
The problem is that austerity in the deficit countries can lead to recession, especially if the surplus keep on lending.

Another option is looser money. But with interest rates at zero, central banks are left to resort to quantitative easing - printing money and using it to buy up debts, or intervening directly in currency markets.

But these are limited tool - as the Japanese have learned over the years.

Many in the US Congress hope that Washington will try another option - trade sanctions against China.