The next financial crisis, according to recent media reports, will be a ‘currency war’. I am not quite sure what this is however I think it is when one country lowers its exchange rate and this leads another to do the same. A series of competitive depreciations follows and this constitutes a war.
Currencies are strange animals, particularly in the current environment where there is no standard of value – that is, there is nothing to judge the value of the USD, or the JPY or EUR or RMB or anything by. The best we can say is USD 1 equals JPY 93, but that says nothing about purchasing power.
In this situation, the so called ‘war’ simply acts to keep relative currency values constant. For instance, if Japan lowers the JPY by 10% against the USD and the US retaliates by lowering the USD by 10%, we are simply back to where we started. Where’s the crisis in that?
Despite the media speculation, any currency crisis will not be sparked by planned warfare, rather it will be driven by uncontrollable currency volatility. How can the Bank of Japan stop the JPY from falling is the real problem now that sentiment is firmly against them?