A currency war is raging across the world, as foreign central banks
ease policy to devalue their currencies and boost exports. And
Mohamed El-Erian, chief economic adviser at Allianz, says the war
might last for a while.
"Not all currencies can depreciate against one another at the same
time. But the current wave of efforts, despite being far from
optimal, can persist for a while, so long as at least two conditions
are met," he writes in an article for
Project Syndicate.
"The first condition is America's continued willingness to tolerate
a sharp appreciation of the dollar's exchange rate." The greenback
has reached multi-year highs against many currencies in recent
weeks.
Given the strong dollar's harm for U.S. companies and our trade
balance, "this is not guaranteed," El-Erian says. "Still, as long as
the U.S. maintains its pace of overall growth and job creation — a
feasible outcome — these developments are unlikely to trigger a
political response for quite a while."
The second condition is "financial markets' willingness to assume
and maintain risk postures that are not yet validated by the
economy's fundamentals," El-Erian writes. "With central banks
pushing for increasingly large financial risk-taking, this is no
easy feat," he adds.
"Central banks will have to back off eventually. The question is how
hard the global economy's addiction to partial monetary-policy fixes
will be to break — and whether a slide into a currency war could
accelerate the timetable."
David Woo, head of global currency research at Bank of America
Merrill Lynch, is concerned about the currency war too. "At this
point, FX volatility has become the prime driver in global
volatility," he says, according to
CNBC.
Indeed, currency volatility has hit a 20-year high for non-crisis
periods by BofA's calculations. "You cannot make any investment
decisions without actually understanding which way the dollar is
heading," Woo says.
The war is self-sustaining. "If everyone's playing this game you
have no choice but to play it, because otherwise you get left
behind," Woo explains. "We call it war because it's a zero sum game.
Somebody wins, and somebody else loses."
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