Currency war: reality or fantasy?

Press release // Every economic cycle has its currency war. In the 1920s, France, Germany and Belgium devalued their currencies to return to the gold standard, abandoned during the First World War. In the 1930s, the world’s major economies resorted to competitive devaluations to regain the prosperity lost after the 1929 American stock market crash. In 2024, the strong dollar could trigger a new currency war, says Johan Gabriels, regional director at iBanPremier, a leading provider of foreign exchange and international payments services for businesses.

Are we heading towards a new currency war? For the moment, 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 rates in May to support the rupiah, while Japan relies on direct purchases of yen in the foreign exchange market.

Mixed success of Bank of Japan interventions

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

Competitive devaluations in Asia

What worries the market is the risk of competitive devaluations in Asia to counter the strength of the dollar. A devaluation of the yuan could be the first domino to fall. This would allow China to regain its competitiveness and revive its export-driven economy to pre-pandemic levels. Analysts have feared this scenario for months.

But is there a real risk? ” We think not. Calls for a significant depreciation (or even devaluation) of the yuan ignore economic realities. China has a significant current account surplus, of the order of 1 to 2% of its GDP. Its trade surplus is 3 to 4% of GDP and that of the manufacturing sector exceeds 10% of GDP. Given the size of the Chinese economy – $18 trillion, or 15% of global GDP – these surpluses are enormous,” says Johan Gabriels.

The risk of capital flight

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

Furthermore, a devaluation of the yuan would only reinforce capital flight, as was the case in 2015-2016. This painful moment in China’s economic history probably prompts Beijing to be cautious in managing the exchange rate. Since the start of the year, China has mainly sought to maintain the stability of the renminbi against the dollar without using the central bank’s vast foreign exchange reserves. Instead, it relied on daily fixing and direct market intervention by state-owned commercial banks to signal that a depreciation of the yuan against the dollar was undesirable.

Currency manipulation?

Unlike the Trump era, the Biden administration seems satisfied with the level of the yuan. China’s current account surplus is not large enough for the U.S. Treasury to consider it a sign of currency manipulation. Furthermore, the growth of China’s foreign exchange reserves is relatively stable, again indicating the absence of manipulation. Finally, Washington is well aware that the downward pressure on the yuan partly reflects the strength of the dollar.

Until the US Federal Reserve moves towards cutting rates – which is not certain this year – the strength of the dollar will remain a problem for China and the rest of the world. However, iBanFirst analysts doubt that the appropriate response to dollar strength is a series of competitive devaluations, particularly in China.