Do We Need To Worry About Currency Tensions & Competitive Devaluations?

It is often said that chaos breeds opportunity, and the nature of currency markets means that major news events, stories and chaos can havinstant forex funding

In particular, currency tensions and competitive devaluations have hit the news lately as political tensions and turmoil have rather directly impacted forex for deliberate reasons bordering on outright strategic.

Many of these decisions happen on a much higher level than traders or investors, but by understanding the general state of affairs and the relationships between the nations that take part in competitive devaluations and currency wars, you can know when to invest and when to take a step back.

What Are Currency Tensions?

Currency tensions, sometimes known by the far more hostile and aggressive term currency wars, are where monetary policy is designed to improve the competitiveness of one nation at the expense of others they are paired with.

The intention is to make export products cheaper, in turn making a country more appealing to trade with, but this, conversely, makes imports more expensive for consumers in a nation.

This can be fine for markets where a nation has domestic alternatives that reduce the need for imports, but it can have the consequence of increasing the cost of living and lowering productivity if a nation is reliant on imported supplies such as equipment and some raw materials.

It is often caused through intentional or unintentional devaluation of a currency through the reduction of interest rates, quantitative easing (a way to add liquidity to a market wherein a central bank buys treasury bonds or other similar assets in bulk) and other protectionist measures.

At its most extreme, it can lead to outright trade tariffs, which contrary to some media reports, are paid by customers importing products, not nations exporting, and can often lead to reciprocal tariffs that cause products to become more expensive in real terms.

What Is Competitive Devaluation?

Competitive devaluation is similar to a currency war but involves a more specific set of tactics and is typically focused on a narrowly focused economic and trade policy.

Whilst currency wars can happen for a variety of reasons competitive devaluation is specifically focused on making exports much cheaper, increasing sales and reducing trade deficits by artificially focusing on exports over imports.

Choosing to deliberately devalue a nation’s currency is a very complex decision to make, often reliant on using foreign investment through purchasing products you export to stimulate economic growth, which can cause trade tensions and increased inflation.

How Do Countries Deliberately Devalue Currencies?

Quantitative Easing: This is a form of central bank intervention where a sovereign bank buys long-term securities to increase the supply of cash, which in turn encourages investment and cash. It invariably leads to inflation but can be necessary in a currency crisis.

Lowered Interest Rates: If interest rates are lower, there is less incentive to invest in a nation from outside, but this, in turn, can make it easier to lend money to people domestically at competitive rates.

Intervention Buying: A nation may purchase assets to lower the value of currency but support prices and encourage stability.

Controlling Flows Of Capital: A more direct form of intervention, a central bank can explicitly link the amount of money that can flow out of or into the country, often primarily focused on avoiding a monetary flight to security.

Diplomatic Interventions: As a lot of value in the forex market is based on the sentiment of investors, telling the right story will often affect the market. Central banks try to avoid this, but it can be difficult to stop when many investors will invest based on market sentiment.

Are They Cause For Concern For Forex Traders?

In general, a sovereign country devaluing their currency is bad for investors who have gone long on said currency, as the currency pair will inevitably drop as a response. By contrast, if you try to short a particular currency, you are set to gain as a result.

This was infamously the case during Black Wednesday, one of the most impactful cases of a currency devaluation (albeit not undertaken deliberately), where George Soros and Stanley Druckenmiller intentionally bet against the British pound, forcing it out of the fixed exchange rate mechanism, and ultimately forcing it out of the single European currency.

Ultimately, competitive devaluation creates a beggar-thy-neighbour situation where a single country benefits in a way that negatively affects other trade partners.