Q&A: Currency the latest threat to global economy

[February 15, 2013]  LONDON (AP) -- The world economy faces a new threat. Instead of a banking collapse or too much debt, fears are growing that countries are using their currencies as an economic weapon.

History suggests that's never a good thing.

If too many countries try to weaken their currencies for economic gain -- sparking a so-called "currency war" -- then the fragile global economic recovery could be derailed and the international financial system thrown into chaos.

Financial representatives from the world's leading 20 industrial and developing nations are gathering in Moscow for a meeting this weekend that looks set to be dominated by these concerns and they will have their work cut out to douse the fires.

Q: Why is everyone suddenly talking about currencies?

A: During the financial crisis of the past few years, the value of currencies wasn't a high priority -- governments and central banks around the world co-operated to fix the global economy. But, five years down the line, a full recovery is still a long way off.

To encourage their consumers and businesses to keep spending, central banks in the U.S., Europe and beyond have made it a priority to keep interest rates extremely low. One way of doing this is to use their power to print money to buy up large quantities of bonds. Boosting the amount of currency in circulation also has a knock-on effect: it can drive down the value of that currency.

Japan, the world's third-largest economy, is currently facing charges that it is trying first and foremost to lower the value of its currency, the yen, to stimulate its economy and get the edge over other countries. The new government is trying to get Japan, which is in recession, motoring again after a two-decade bout of stagnant growth and deflation. Earlier this week, the yen fell to a 21-month low against the dollar and a near three-year trough against the euro. As the yen falls, its exports become cheaper and those of Asian neighbors South Korea and Taiwan, and further afield in Europe, become relatively more expensive.

Q: Is Japan trying to weaken the yen?

A: Yes and no. Though it's not directly intervening in the foreign exchange markets by selling yen and buying other currencies, the new Japanese government has embarked on an economic course it hopes will finally kick-start the economy. The government has already pushed the Bank of Japan to accept a higher inflation target. This has triggered speculation the bank will create more money. The prospect of more yen in circulation has been the main reason behind the yen's recent fall to a 21-month low against the dollar and a near three-year record against the euro.

Japan's Finance Minister Taro Aso doesn't appear to be holding back on the success of the policy. Though he insists the government hasn't been directly intervening in the currency markets, he says the world "has been awed" by the recent surge in share prices and that the weakening yen has "brought huge benefits to the export sector."

Q: Will a lower yen help Japan?

A: It can help exporters, such as Sony and Toyota, thereby lifting growth. A lower currency can also stoke inflation by making imports more expensive. For a country that's seen prices fall for a large chunk of the past two decades, that may be no bad thing. But if other countries respond to the falling yen by devaluing their currencies, Japan will struggle to achieve its objectives -- back to square one.

Q: Have other countries been manipulating their currencies?

A: In Sept. 2011, Switzerland took action to arrest the rise of its currency, the Swiss franc. The rise was triggered by the debt crisis afflicting the 17-country eurozone -- investors were looking for somewhere safe to park their cash and the Swiss franc has traditionally fulfilled that role. The Swiss intervention was viewed as an attempt to protect the country's exporters.

The appropriate level of currencies was a hot topic of debate before the financial crisis. For years, U.S. politicians have accused China of keeping its currency artificially weak in order to industrialize fast. And the U.S. was widely seen to have abandoned the "strong dollar" policy at the core of the Clinton administration's economic policy in a dash for growth.

Q: So why the fears that Japan might start a new currency war?

A: Getting an edge from a lower currency may be seen as an easy way of "trying to spark economic recovery," according to Neil MacKinnon, global macro strategist at VTB Capital.

It's the desire to eke out growth that's behind the talk of currency wars and the focus on the yen.

So far, Europe has felt the impact of the falling yen the most. At the height of the eurozone's financial crisis last year, the euro was worth $1.21 -- to the potential benefit of big exporters like BMW or Airbus. However, this week it's at $1.33 even though the eurozone is still the laggard of the world economy. Figures Thursday showed that the economic output of the 17 European Union countries that use the euro shrank at an annualized rate of around 2.5 percent in the last quarter of 2012.

A rise in the value of the euro, which is also partly to do with the diminishing threat of a collapse of the currency, will do little to help companies in the eurozone -- and will hardly help getting it growing again.

Politicians have voiced concerns about the euro's value -- notably French President Francois Hollande, who indicated he was open to calls for a more managed exchange rate. European Central Bank President Mario Draghi said last week that the bank will monitor the economic impact of the euro's rising value. Several analysts took that to mean the ECB could cut interest rates to bolster growth, which in theory could weaken the euro -- an indirect tit-for-tat response to the yen's fall, some say.

Earlier this week, the volatility in the currency markets prompted the Group of Seven leading industrial nations, which includes the U.S, Germany as well as Japan, to warn that volatile movements in exchange rates could adversely hit the global economy and to reaffirm their commitment to market-driven exchange rates.

Q: How bad could a currency war get?

A: Since World War II, one of the key objectives of international economic policymaking has been to avoid a repeat of the 1930s, when countries around the world engaged in a tit-for-tat battle with their exchange rates. That decimated global trade, accentuating the depression and providing another catalyst to war.

Assuming the world doesn't descend into a similar abyss, a currency war can still harm the global economy. For example, central banks, particularly in the developing world, may resort to controlling the amount of capital that can be moved out of a country to affect exchange rates.

"Increasing impediments to the free flow of capital might be thought to lower the potential growth of the world economy," said Stephen Lewis, chief economist at Monument Securities.

And even if capital controls are avoided, violent fluctuations in the value of currencies sparked by a currency war don't encourage businesses to invest- raw materials and components shipped in from abroad would become increasingly difficult to cost and the value of any money invested in a country could quickly be wiped out.

Q: Can the world's leaders and central bankers calm the situation?

A: No doubt, a communique will emerge from this weekend's G-20 meeting in Moscow that pours scorn at competitive devaluations. Most of the action, though, is likely to take place behind-the-scenes with pressure expected to be put on the Japanese finance minister and central bank governor not to allow the yen to fall much further.

"Expect smoke and mirrors," said Simon Evenett, a professor of economics at the University of St. Gallen in Switzerland and a former World Bank official. "It's not the G-20's style to point fingers."

[Associated Press; By PAN PYLAS]

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