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Currency Wars: what are they and why do they matter?

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The UK, US and Japan are trying to drive down the value of their currencies. What's going on?

by Gavin Lumsden on Feb 08, 2013 at 15:11

Currency Wars: what are they and why do they matter?

I visit the Imperial War Museum to talk about 'currency wars' and why countries like the UK, US and Japan are competing with each other to weaken their currencies.

This is the latest video in The Lolly Investor Programme series aimed at explaining the basics of investing to ordinary people. 

Can't watch the video right now? You can read my script instead.

Hello, our political and economic debates are often framed in terms of struggle and of war.

In recent years we’ve had the war on terror and then the war on the economy as we strived to get over the 2008 financial crisis.

I’ve come to the Imperial War Museum in south London because right now the hot topic in financial circles is the currency war being waged by the big guns of the global economy.

In the currency war countries like the UK, US, Japan and to a certain extent the eurozone are engaged in a competition to drive down the value of their currencies.

Sounds crazy doesn’t it?

In investing, we’re trying to grow and increase the value of our money. Why on earth then would countries want to devalue the notes in their citizens’ wallets?

Because by lowering their currencies countries hope to boost their exports because it becomes cheaper for people in another currency to buy their goods and services.

Countries like the UK also want to reduce their dependency on financial services and expand the role that manufacturing plays in the economy.

An export drive led by a weak pound is a key part of this strategy.

So how do countries achieve a weaker currency?

It’s simple, they print more of it!

Yes, the currency wars we’re talking about are a result of the controversial quantitative easing policies of the Bank of England and the US Federal Reserve.

When I looked at QE before I explained how these central banks created huge sums of new money in order to lower long-term interest rates. They did this by using the new money to buy their governments’ bonds.

A side effect of all this new money and the ultra-low interest rates it caused meant the pound and the dollar were a bit less attractive for overseas investors to hold. The currencies fell, exports rose, the central bankers patted themselves on the back.

A weak currency can lead to higher inflation, however. The flipside of making exports cheaper is that imported goods become more expensive. Unless you stop imports altogether the risk is inflation will rise.

After the financial crisis the Bank of England was worried about deflation and an economic slump. It wanted a bit more inflation to get the economy going so didn’t mind taking that risk.

Nowadays, we’re getting a bit more concerned about where inflation may be heading.

The other trouble with currency wars is the idea can catch on.

The term currency war was first used when the US launched its QE programme in 2009. Recently it’s been revived because the new government in Japan has signalled it wants to get far more aggressive with its QE policies.

Japan has suffered from deflation, that’s falling prices, and an overvalued currency, the yen, for many years. This has made its exports expensive and hit the profits of its big firms.

Prime minister Abe is doing something about it, pressuring the Bank of Japan to adopt similar policies to the UK and US.

The result has been impressive. The yen has slumped and share prices on the Tokyo stock exchange have soared.

The problem is where will it end?

A series of tit-for-tat moves by countries weakening their currencies could lead to governments taking steps to restrict imports from those countries.

A new era of protectionism would reduce world trade and damage the global economy. The stakes are high.

The currency war also produces some bizarre results.

The euro – which we were worried could break up a year ago, causing financial mayhem – has recently risen on currency markets  – because its QE policies are weaker than those of the UK, US and Japan.

Countries like Germany, France and Spain are worried that the strength of the euro will make it difficult for the eurozone to climb out of recession.

Meanwhile, the US dollar doesn’t always do as badly as you might think, given it has an enormous QE money printing policy and has a huge budget deficit as a result of years of over spending to sort out.

Because the US is the world’s biggest economy, the dollar is the world’s reserve currency. People will want to do business in dollars regardless of whether or not they think the US is on the skids.

Where does this leave investors? Nowhere much.

Currency movements can be frustrating if you’re investing overseas. For example, if the pound is weak against the currency of the country you’re investing in, it will reduce some of your returns.

That said, the opposite can happen just as easily.

That’s why currency markets are often described as a zero sum game because the rises and falls of currencies against each other tend to even out over time.

Some investment funds offer share classes that hedge out or remove the currency risk. However, they can be expensive and do not have a long track record.

We just have to hope governments don’t get too carried away with their currency wars.

21 comments so far. Why not have your say?

Jeremy Bosk

Feb 08, 2013 at 15:45

Thank you for the transcript which, if extended to all videos, would save us all so much time. The printed word, perhaps with a graph or two where relevant is so much better.

You are a good presenter and have an engaging manner, so it is not at all personal :-)

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Alan Tonks

Feb 08, 2013 at 18:15

What do we export which is actually British, the answer to that is very little. This apart can you trust our inept Government, the answer to that is no.

This Government does have an agenda and its one that bodes nothing but misery for the thrifty.

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Jeremy Bosk

Feb 08, 2013 at 20:07

It is not the origin of the physical parts of our exports that makes the most money but the intellectual property. Patents and copyright are more profitable than mining ore, processing the ore into ingots, bashing the ingots into machinery parts and screwing the bits together. Most of that can be done more cheaply elsewhere. ARM is the exemplar. Its designs are in most of the world's mobile phones and they get a royalty on each one. Whether the bits are made in China or the USA, assembled in Mexico or Vietnam.

I entirely agree with your opinion of the Unholy Trinity - Cameron, Clegg and Osborne.

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an elder one

Feb 08, 2013 at 23:07

It's not only the chips Jeremy, but also the synthesis of the products of mining and their transformation through inventive processes with materials and product design; as regards manufacture, robotry (chips there too) increasingly replaces human effort.

China and Co. have some bright people too and are catching up, they won't provide cheap labour for ever; we need better education here in UK in that regard to maintain such leads as we possess and for finance to be less self serving and assist. Intellectual effort is only protected for a while.

As regards your last point, I think some of the gang are trying; if only they'd give up on politics; a coalition of egos don't help!

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Jeremy Bosk

Feb 09, 2013 at 01:26

an elder one

I entirely agree with your paragraphs one and two. Which makes the raising of higher education tuition fees crazy. The attempts to limit immigration of overseas students and stop them working here after they graduate is also crazy. America's growth companies are almost all founded by Chinese, Indians and Russians who came to study and stayed to create jobs for the natives.

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William Bishop

Feb 09, 2013 at 10:07

Apart from the yen just recently, the main feature of currency markets for some while has been lack of volatility. Maybe following similar policies in different countries merely produces stalemate - most policy objectives in any case seem to give primacy to the domestic economic effects and not the international ones. (At one time the Fed used to list the main factors affecting its monetary policies - currency movements had to get really extreme to achieve any kind of headline billing).

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Jeremy Bosk

Feb 09, 2013 at 11:00

William Bishop

Most sane people (which excludes politicians) agree that currency wars are counter productive and can lead to tariff wars and a 1930s style slump. Probably only America, China and possibly the EU (if and when it gets its act together) and Japan are big enough, on their own, to have much influence on the world foreign exchange markets. OPEC has probably lost that ability.

I generally ignore currency movements on the grounds that it will all come out in the wash and anyway forecasting them is too difficult.

Having written this, I took a look at the EURO / GBP chart for the last ten years and see that there was a very steep strengthening of Sterling from 2007 to 2009 - around 30 per cent. Similarly there was a 40 per cent appreciation of the Pound against the USD. Which can have done little good to our exports. I remember reading about the Pound as a safe haven currency from the expected break up of the Euro and the US trade deficit.

Such rapid and extreme currency fluctuations must make pricing for overseas markets hard. Also, anything produced in the UK from imported raw materials or semi-manufactures must have its profit margins fluctuate like a yo-yo. If manufacturing cannot hope to forecast its input costs in this country, it will move abroad. That is on top of any arguments about relative labour costs. That seems the conclusive argument against the likely revival of UK mass production industries.

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Jeremy Bosk

Feb 09, 2013 at 11:06

Gavin

As well as providing a transcript of videos, do you think you could turn off the autoplay feature on them? I like to listen to music while reading and a sudden blast of video sound over one of the quiet bits in Beethoven's Third Piano Concerto is irritating.

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William Bishop

Feb 09, 2013 at 14:34

Unless my memory is failing, Jeremy Bosk has it the wrong way about - surely the pound weakened, not strengthened, in 2007/09. It still didn't seem to do much for our exports, though, partly because of economic weakness generally, but also, as it appeared, because British exporters saw it more as an opportunity to fatten their profit margins than to boost sales.

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an elder one

Feb 09, 2013 at 15:31

We spend far too much time reviewing the vagaries of finance as an instument for successful competition in trade and enhancing self serving profit for its plutocrats; the country as a whole would be better served honing its inventive wits to produce desireable things for trade that can surmount any barriers to trade. We have evolved a muddled culture in this country through excessive pragmatism coupled with complacency and a misguided ideology of what constitutes fair shares.

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Jeremy Bosk

Feb 09, 2013 at 19:52

William Bishop

You are quite right. I obviously read the charts the wrong way around this morning. Apologies to all.

an elder one

That seems to work well enough for the Germans. Of course they have a much more science / technology / engineering oriented education system.

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an elder one

Feb 09, 2013 at 22:19

Jeremy, I worked with german engineers in the motor industry and they are indeed very thorough, perhaps a little too systematic for Brits; on the other hand I found that in some ways us Brits to be a little more imaginative and inventive through being less constrained by methodology; somewhere between us lies perhaps an ideal. Certainly, our education system should have more emphasis on science and engineering in all its faculties.

Sorry, I do tend to get off the subject!

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Jeremy Bosk

Feb 10, 2013 at 00:04

an elder one

What you have to say is usually interesting so excursions are welcome.

I started out at school wanting to be a chemical engineer. A school that left its pupils with no maths lessons in the third and fourth forms, for eighteen months, put paid to that. I am still angry after fifty years.

There should be properly qualified maths teachers for all children and a remedial system for those that struggle. At present it appears that most teachers of maths have degrees in everything but that subject. How can anyone teach a subject with which they are not thoroughly conversant? All children should be taught at least some of the time by practising scientists and engineers able to communicate the practical uses of their subject.

That is my excursion for the night.

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an elder one

Feb 10, 2013 at 11:45

Jeremy, reflect on that cruel dichotomy related to teaching, in words to the effect: 'those that are able to put knowledge into practice, do so; those that aren't, teach'.

Most of teaching in Britain seems based on learning as an unsullied intellectual pursuit with little or no regard for the practical demands of life. It seems that despite that, in varying degree, some of the populace have the inate ability, drive, whatever, to discover, themselves, their role in life. It seems so often that the teaching profession are unable to understand, or no wish to understand, such promises, thus are unable to provide the appropriate course of learning for the individual student.

It shouldn't be that way, somewhere in 'the establishment' it should be recognised that a system is needed to provide a practical course of education for the individual case - where called for - based on the demands of an endeavour and industry outside of academe.

That said, I've nothing against academe; after all it is the essential study of nature in all its variety and the nature of human existence; but I have lived, I confess, with some resentment at the apparent arrogance of that profession.

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Jeremy Bosk

Feb 10, 2013 at 13:39

an elder one

I have some sympathy with your view of the dichotomy. It would plainly be beneficial if would be teachers were recruited only after gaining some outside "practical" experience. Trying to force everyone down the academic path is stupid. I say this as one whose idea of heaven would be to learn and teach forever.

I remember how upset one school teacher became when I asked him what was the point of history. Which happened to be one of my best subjects because I enjoyed it and read it for personal interest. His baffled answer was, "If you don't like it, you don't have to study it". Missing my point completely. Nowadays, I could defend it quite well. I even get angry at the present government's attempts to replace serious study and understanding of the world with Little England, jingoistic sloganising.

The best teachers I ever had were lecturers on my course in Computer Studies (computers plus some relevant maths and business) who had business experience. On that course I was given remedial teaching in Maths - having barely scraped an O-level twenty years earlier. But was simultaneously roped in to tutor a new lecturer in the use of several software packages with which he was unfamiliar.

So I am a strong believer in an individual approach to learning. Which implies smaller class sizes or computer based learning, with human supervision, which allows for different learners going at different paces.

The "whole class" approach to setting is another unnecessary evil. My school days were a mixture of thinking about other things while teachers droned on repeating what I understood the first time, and being myself one of those kids without a clue: all depending on which subject it was.

Now we are very off topic and who cares?

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Jeremy Bosk

Feb 10, 2013 at 13:52

William Bishop

Reverting to exchange rate instability. Even though Sterling weakened, making exports more profitable, industry chose to take higher profit margins rather than invest and sell more. Why? Could it be the same thing, complete distrust of any ability to forecast future currency movements? Uncertainty makes planning almost impossible. Why build a new factory if currency movements will soon revert to the mean and even swing from weakness to strength? A new factory whose markets have suddenly disappeared is neither use nor ornament.

We need either stable currency - keeping any currency stable in these days is a tall order, look at the Dollar and the Renminbi - or affordable hedging. Hedging is an expense, so we need high margins. Which comes back to concentrating on items with pricing power and low raw material content. Which needs graduates and highly trained technicians rather than unskilled labour.

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John Harmer

Feb 10, 2013 at 17:27

Back to the 1930s, soon a rerun of ww2

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an elder one

Feb 10, 2013 at 18:36

I don't pretend to understand with any sort of qualification, the matter of economics and financial jiggory pokery, but from a common sense, or natural, viewpoint it seems to me that our current condition derives from the corruption of its natural laws by politicians, over-concerned with ideological concerns, perpetrated in order to engender support from a largely ignorant plebiscite.

This suggested to them that, the faster growth needed in order to cover the aims of a redistribution of wealth and a wonderful feeling for all, could be brought about by simply throwing money at anything and everybody (the helicopter syndrome!) which unfortunately, ignored the fact that it could never show a truly profitable return in our present economic condition.

The fast rates of growth in developing economies such as China et al - working at catch up with the West - provide no example for us - an allegedly mature society - where a natural rate is probably nearer 2 or 3% (I don't know; I'm not up on such statistics).

The evident key to the solution is a more competitive trading performance to be accomplished by improving our ability to produce things that the world would like to buy and can afford surmounting the costs of importing raw materials; unfortunately it's a longish term remedy.

Hence we are well and truly faced with a bewildering condition that should never have occured, the remedies being only to patch up as best we can and beggar thy neighbour, periodically - if it seems to work - with the exigencies of notional recovery.

Thus it seems that things have to be tried by those who presumably know something of the business, and we wait and see how things progress. It seems to me pointless to argue the point regarding the likely remedies for something of an abortion; pity it wasn't stopped at its genesis.

Just thinking aloud!

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an elder one

Feb 10, 2013 at 21:01

The joke on us, is that our relativity inefficient industry - due partly to high labour cost at home - has been augmenting the income of China and India by employing their cheap labour, whereas we should have been seeking ways to make our industry more efficient, by investing in new technologies to replace the expensive labour; add to that we, in our patronising fashion have been pouring foreign aid out to some of those notionally underdeveloped countries.

Add further to that, our much esteemed finance business doesn't seem to have, overall, served us too well.

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Jeremy Bosk

Feb 10, 2013 at 22:14

John Hamer

I fully expected revolution and a fascist takeover in one of Greece, Spain or Portugal well before now. Maybe we will escape that. I hope so.

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Jeremy Bosk

Feb 10, 2013 at 22:32

an elder one

I wish I could believe that the present government was remotely interested in the welfare of the poor. Instead, they have the most callous and malicious attitudes of any government since sometime in the 18th or 19th centuries.

Some sectors of our industry have modernised and become profitable even in today's environment. Aerospace, armaments, software, the foreign owned motor manufacturers, oil and gas equipment manufacturers and yes, even finance come to mind.

Finance is a lot more than investment banking - which I excoriate as much as anyone else. Insurance and reinsurance; ship broking; asset management, outsourcing, asset finance of ships, planes, trains, infrastructure; project finance of mines and oil and gas and so on. Investment bankers were never more that a few thousand people, the rest of finance employs millions who mostly do an honest day's work.

As for foreign aid, sometimes it buys influence and paves the way for more commercial activities and sometimes it just is really and dreadfully needed. Of course a lot of waste and inefficiency could be saved if we could build honest government and efficient distribution networks all over the world. Some aid agencies do work on those things. Meanwhile we are faced with starving children and refugees fleeing persecution by bandits and religious maniacs. Mali comes to mind as a recent example. I don't mind some of my taxes going to help such people. It would have to be from my indirect taxes such as VAT because I am too poor myself to pay income tax or CGT.

Nil desperandum.

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