Global currency wars a risky zero-sum game for world economy

Global policymakers are digging themselves into a very deep hole with few viable exit plans. Growing turmoil on financial markets and deepening world economic gloom is leading policymakers to turn to desperate measures to beat the downturn.

Pumping the global economy with huge infusions of quantitative easing money and driving interest rates into negative territory are proving less effective in stopping the rot. The worry is the world’s central banks and governments are being tempted into competitive currency devaluation as a last resort to reboot faster growth.

It is a mistake as currency devaluation in the long run is a zero sum game. There may be some short term benefits, but, as everyone joins in, it ends up a no-win situation. It raises the spectre of a dangerous currency war breaking out, increases trade tensions and exposes global investors to more risk in the process.

Currency devaluation is like pyramid selling. It may work temporarily for countries which are the first in to use it, but other countries adopting the strategy at a later stage will see any potential benefits cancelled out as other nations join in the devaluation merry-go-round.

For currency devaluation to work effectively, it must be backed up by other complementary measures. Monetary, fiscal and currency policies all need to be pulling in the same direction to ensure the resulting stimulus is channelled to maximum effect.

The experience of the US and British economies in the wake of the 2008 global financial crisis are good examples of how currency depreciation works when properly handled. By slashing interest rates and unleashing significant QE programmes, the US Federal Reserve and the Bank of England both ended up weakening their currencies. It was anathema to investors, who fled the US dollar and British pound in droves.