Currency wars

Earlier in 2014 the slightly bombastic term, 'currency war' hit the newspaper headlines as the Japanese yen fell sharply in value against other major currencies. At the time, some European finance leaders voiced their concerns over the Japanese currencies free-fall and its potential impact on European exporters, and cited it as part of a currency war. For various reasons, we believe that we may well be hearing more about currency wars over the course of the year.

So what is a currency war and why is it important?

It is a term used to describe when countries, often as a last resort, use debasement of their currency to try to gain a competitive export advantage over each other. The most significant currency war was in the 1930's between Great Britain, France and the US. Another description for the practice, or more accurately its effect, is 'beggar thy neighbour'. As country after country, while seeking to take their neighbours exports through a cheaper currency, ends up simply impoverishing their own consumers through higher import costs, in addition to their neighbours exporters. An additional concern is that currency wars are dangerous games for neighbouring nations, such as Japan and China, with significant territorial differences to engage in.

Jostling Asian currencies

As we end 2014, concerns over currency devaluation have again come to the fore. The trigger has been three fold: the surprise interest rate cut by the Bank of China, the decision of the Japanese Prime Minister, Shinzo Abe,
to call a snap election for December 2014, and continued deflationary prospects in Europe.

The cut in Chinese interest rates in November, which was the first cut in two years, was a result of a stalling economy in China, neither of which will increase the currency's appeal to investors. Having allowed the yuan to strengthen during the past couple of years, this move by the Bank of China has provoked concerns that this is the first stage in trying to reboot the Chinese economy by keeping the currency weak. By contrast the Japanese election is specifically aimed at gaining a popular mandate for 'Abenomics' and a return of Abe's government would likely presage further yen devaluation. Pressure could now build within other Asian currencies to respond by taking steps to ease their monetary policy, or face the risk of being squeezed between their more powerful neighbours.

Stagnant Europe

Alongside these moves in Asia, we have seen increased action by the European Central Bank in providing more stimulus to their struggling economy. European manufacturers were indeed affected by the Japanese devaluation and, with continuing stagnation and deflation in Europe, there is a growing need for an increased level of central bank action. Continued talk of European quantitative easing suggests it may well be that yet another devaluation player may soon be on the scene.

The key to all this is that outside of the American (and to a lesser degree the British) economy, there is simply not enough growth to go round and so an increasingly aggressive fight is now likely to be waged by faltering and highly indebted economies, in the hunt for sufficient growth which will meet their needs. In particular Japan, China and Europe look likely to take steps to engage in various forms of currency debasement. Consequently a currency war will have ensued in every effect,
if not in name.

Until we return to a normal cycle, the volatility of currencies and the divergence of policy between different countries are likely to have a marked impact throughout the upcoming year. It looks like it will be an important year to focus on currency selection.

Claire Bennison is regional director at Brooks Macdonald in Manchester

She writes a regular in-practice article on asset management for Private Client Adviser