Strong currencies amid high inflation may lead to a reverse currency war. : The Indicator from Planet Money As countries crank up their interest rates to fight inflation, the whispers of a reverse currency war are getting louder. But is this cause for concern or just political posturing?

The rumbles of a reverse currency war

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And I'm Adrian Ma. Central banks around the world right now are taking actions to try to get inflation under control. Consumer prices are still high in a lot of places, including the U.S., where June CPI figures just came out, and the inflation number is 9.1% higher than a year ago. That is even higher than was expected.

WONG: By now, you can probably rattle off all the different steps the Fed is taking to tame inflation. It's hiking interest rates and doing this thing called quantitative tightening, basically offloading bonds to shrink the money supply.

MA: Now, a lot of times when we talk about inflation, we're only talking about how it affects us, like, here in the U.S. But of course, we live in a connected world - a world where what countries do with their economies affects other countries. And when a bunch of central banks around the world are doing what the Fed is doing to try to fight high inflation, that can get the global economy into a situation with a controversial, largely political name - a reverse currency war.

WONG: Today on the show, we unpack this inflammatory term to learn why the drumbeats of a reverse currency war are getting louder.

MA: Right after the break.


WONG: Before we get into a reverse currency war, we should talk about the regular version. Brazilian Finance Minister Guido Mantega is credited with coining the term currency war back in 2010 in the aftermath of the global financial crisis.

MA: Randy Kroszner is an economist at the Booth School of Business at the University of Chicago, and he remembers the term currency war seemed to catch on right away.

RANDY KROSZNER: That was a great phrase. It was perfect for social media. And boom - it was a currency war.

MA: Boom. But what did the Brazilian finance minister mean by currency war? Well, what he meant was advanced economies like the U.S. and Europe and Japan were deliberately devaluing or weakening their currencies to gain an edge in international trade.

WONG: And here's how that works. When a country's currency loses value or gets weaker, that country's exports, the stuff it sells overseas, get cheaper. So that country is able to sell more stuff and grow its economy.

MA: Where the trouble starts is if a country looks over at its neighbor and says, hey, they're weakening their currency. We got to keep up. So that country weakens their currency in response. And the sort of polite econ vocab term for this is competitive devaluation. But what the Brazilian finance minister did in 2010 was sort of, like, dial up the rhetoric by calling it a currency war.

WONG: He dialed it all the way to 11.

MA: Currency war - yeah.

WONG: And this term was kind of a shorthand to assign blame for what was happening in the global economy at the time. Kathryn Dominguez is an economist at the University of Michigan. She says everyone wanted to grow their economies to get their footing back after the financial crisis.

KATHRYN DOMINGUEZ: Generally, the idea for a currency war is that all countries are trying, at the same time, to stimulate their economies and are trying to do it, in some sense, by trying to get an unfair trade advantage against other countries.

WONG: The currencies trade against each other. So when the dollar went down, the Brazilian currency, the real - it went up. And that made Brazilian exports less competitive. That's what the country's finance minister was so upset about.

DOMINGUEZ: That's the tricky part with exchange rates. It's impossible for all countries to achieve a devaluation or a depreciation at the same time.

MA: And that's where the war part of this phrase comes in, right? By using the term currency war, the Brazilian finance minister was accusing the U.S. of weakening the dollar on purpose. Randy Kroszner says he was casting the Fed and the U.S. as villains.

KROSZNER: So it tries to provide a motivation for what's going on rather than just a description of, well, the Fed is trying to make sure that the U.S. economy recovers. And in order to do that, it's going to take - undertake the policies that it feels are best to reach its objectives.

WONG: One of those policies in 2010 was keeping interest rates at zero. With interest rates at rock bottom, investors looking for better returns moved their money into countries with higher interest rates - countries like Brazil. And those investors needed local currency to buy, say, Brazilian bonds. So demand for the Brazilian real went up, and that made the real appreciate vis-a-vis the U.S. dollar.

MA: Another Fed policy from that time was buying bonds to pump money into the U.S. economy, aka quantitative easing. And what happened was the expanded supply of money in the U.S. put downward pressure on the dollar and made it weaker.

WONG: So to sum up, U.S. monetary policy was creating conditions where the dollar was getting weaker, and the Brazilian real was getting stronger. Now, was the Fed doing this on purpose? The Brazilian finance minister said yes. But economist Randy Kroszner says the Fed was just doing what every central bank is supposed to do - look out for its own economy.

KROSZNER: The Fed does take into account the consequences for the global economy. But the mandate that Congress has given it is to focus on the U.S., just as every other central bank is focused on their domestic economy.

WONG: And right now, everyone is focused on taming inflation in this pandemic world, which brings us to a reverse currency war.

MA: The reverse currency war - OK, so another intense-sounding term. If a currency war is a situation where currencies are weakening across the board like we saw in 2010, then a reverse currency war is where the currencies are getting stronger like we're seeing now.

WONG: That's right. Like, central banks are all raising interest rates and unloading bonds from their balance sheets. This leads to their currencies getting stronger. Now we're in a situation called competitive appreciation, which sounds really nice at first, like you're in a contest to see who can deliver the best compliment.

MA: But, you know, the reality of economics is not always so nice. A country that relies on imports, for example - they will see their costs of goods go up as foreign currencies appreciate. And that would feed inflation they're experiencing on top of all the pandemic supply chain stuff they're already dealing with.

WONG: Many of these countries are also emerging economies that are seeing investor money leave for places with higher interest rates like the U.S. And when investors leave, they sell the local currency and buy U.S. dollars. So that local currency goes down, and the U.S. dollar gets stronger.

DOMINGUEZ: From an emerging markets perspective, that could lead them to make allegations of a reverse currency war because their view might be, the policies put in place by countries like the United States are now putting them at a disadvantage.

WONG: Another big danger for emerging economies is that when the pandemic hit, a lot of countries borrowed money in dollars to help tackle the crisis. With the dollar getting stronger, those countries now have to generate even more revenue in their local currency to pay back their dollar-denominated debt.

KROSZNER: This reminds me of a classic quotation from former Treasury Secretary John Connally in 1971 who said, the U.S. dollar is our currency and your problem. So we're going to do what we think is best for the U.S., as everyone should do for their own currencies. But it can be a much larger problem for other countries than for the U.S.

MA: Our currency and your problem - well, as far as we can tell, no government official is crying reverse currency war right now. But there are some, you know, rumbles in the financial press that the conditions for a reverse currency war are here. And Randy says this is why central banks have to act with urgency to get inflation under control.

KROSZNER: If you don't act quickly, inflation expectations become entrenched. That's the risk of waiting. And then they have to raise rates much, much higher. And you will have only seen the beginning of a reverse currency war, if that's the case.

WONG: That doesn't sound good. I'd rather try to make the other version of competitive appreciation a thing. Like, Adrian, thank you for helping me explain the art of currency wars on today's episode. It was very heavy metal of you.

MA: And this is where I try to one-up you, I guess. No, no, Wailin, thank you for being just a lovely human being. And just spending time in your presence is such a treat.

WONG: OK, now I'm going to one-up you by sending some appreciation to a whole list of coworkers. So this episode of THE INDICATOR was produced by senior producer Viet Le with engineering from Gilly Moon. Kathryn Yang checked the facts. Kate Concannon edits the show. And THE INDICATOR is a production of NPR.

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