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What Is a Currency War?

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yuan-dollar.jpg

China keeps the value of its currency, the yuan, lower than the dollar to increase its exports.

Photo: Doug Armand/Getty Images currency_collapse.jpg

Currency wars can lower the value of all currencies.

Photo: Doug Armand/Getty Images

Definition: Currency wars is a term coined by Brazil's Finance Minister Guido Mantega to describe the 2010 effort by the United States and China to have the lowest value of their currencies. Low currency values aid exports by making them cheaper in comparison to other currencies.

The U.S. allows its currency, the dollar, to devalue by expansionary fiscal and monetary policy. It's doing this through increasing spending, thereby increasing the debt, and by keeping the Fed funds rate at virtually zero, increasing credit and the money supply.

China keeps its currency low by pegging it to the dollar, along with a basket of other currencies. It keeps the peg by buying U.S. Treasuries, which limits the supply of dollars, thereby strengthening it. This keeps the yuan low by comparison.

The European Union entered the currency wars in 2013, to boost its exports and fight deflation. The European Central Bank (ECB) lowered its rate to .25% on November 7, 2013. This drove the euro to dollar conversion rate to $1.3366.

Brazil and other emerging market countries are concerned because the currency wars are driving their currencies higher, by comparison. This raises the prices of commodities, such as oil, copper and iron, which are their primary exports. This makes emerging market countries less competitive, and slows their economic growth. 

In fact, India's new central bank governor, Raghuram Rajan, criticized the U.S. and others involved in currency wars that they are exporting their inflation to the emerging market economies. Rajan has had to raise India's prime rate to combat its inflation, risking slower economic growth. For more, see What You Need to Know About the Emerging Market Crisis. Article updated April 22, 2014

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