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Every economic cycle has its currency war

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In the 1920s, France, Germany, and Belgium devalued their currencies to return to the gold standard, which had been abandoned during World War I. In the 1930s, major global economies resorted to competitive devaluations to recover the prosperity lost after the 1929 American stock market crash. In 2024, the strength of the dollar could trigger a new currency war, explains Johan Gabriels, Regional Director at iBanFirst, a leading provider of foreign exchange and international payment services for businesses. 

Are we heading towards a new currency war? For now, only a few countries are intervening to counter the collapse of their currencies against the US dollar. These countries have one thing in common: they are all in Asia. Indonesia raised its rates in May to support the rupiah, while Japan is relying on direct yen purchases on the foreign exchange market.

Mixed success of Bank of Japan’s interventions 

According to the latest estimates, the two interventions by the Bank of Japan earlier this month cost 60 billion dollars. Japan has ample foreign exchange reserves and, in theory, can continue to intervene. However, the effectiveness of a unilateral intervention is doubtful. In the past, successful interventions were coordinated and aligned with monetary policy. For Japan's intervention to be effective, the US Treasury would also need to buy yen, which is not currently planned. Additionally, the Bank of Japan would need to further normalise its monetary policy, as an ultra-accommodative policy is incompatible with a strong currency in the long term.

Competitive devaluations in Asia 

What the market is concerned about is the risk of competitive devaluations in Asia to counter the strong dollar. A devaluation of the yuan could be the first domino to fall. It would allow China to regain competitiveness and boost its export-driven economy to pre-pandemic levels. Analysts have been fearing this scenario for months.

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But is there a real risk? We don’t believe so. Calls for a significant depreciation (or even devaluation) of the yuan ignore economic realities. China has a significant current account surplus, around 1-2% of its GDP. Its trade surplus is 3-4% of GDP, and the manufacturing trade surplus is over 10% of GDP. Given the size of the Chinese economy—18 trillion dollars, or 15% of global GDP—these surpluses are enormous”.

The risk of capital flight 

However, this does not mean that there are no problems. Many exporters are not converting their profits into renminbi. Due to interest rate differentials and a lack of confidence in Chinese policy, capital outflows are significant. In 2023, they reached their highest level in five years, reminding authorities of bad memories. 

Moreover, a yuan devaluation would only reinforce capital flight, as was the case in 2015-16. This painful moment in China's economic history likely makes Beijing cautious in managing the exchange rate. Since the beginning of the year, China has mainly sought to keep the renminbi stable against the dollar without using the central bank's ample foreign exchange reserves. Instead, it has relied on daily fixing and direct intervention in the public commercial banks' market to signal that a yuan depreciation against the dollar is not desired.

Currency manipulation? 

Unlike the Trump era, the Biden administration seems content with the yuan's level. China's current account surplus is not high enough for the US Treasury to consider it a sign of currency manipulation. Additionally, China's foreign exchange reserves growth is relatively stable, further indicating no manipulation. Lastly, Washington is well aware that the downward pressure on the yuan partly reflects the strong dollar.

As long as the US Federal Reserve does not move towards lowering rates—which is uncertain to happen this year—the strong dollar will remain a problem for China and the rest of the world. However, iBanFirst analysts doubt that the appropriate response to the strong dollar is a series of competitive devaluations, especially in China.

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