Reply #10: World must let US dollar win currency war [View All]

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http://economictimes.indiatimes.com/markets/forex/world-must-let-us-dollar-win-currency-war/articleshow/9623324.cms

HONG KONG: Currency wars have returned, and this time the world has little choice but to let the United States win. The Fed's vow to keep US interest rates near zero until 2013 heralds a prolonged devaluation of the dollar. For export nations, the temptation is to fight back by pushing their own currencies lower. That's a mistake. Tit-for-tat devaluations are futile, and would delay the recovery of exporters' number one customer, turning a global slowdown into dreaded stagflation.

Cheap dollars threaten to revive the carry trade, where investors flock to high-yielding assets, such as the currencies of fast-growing countries. Where they go depends on how the U.S. economy responds. If recession is averted, investors will choose markets with growth like Indonesia. If not, they'll favor those that seem safe, like Japan. Some currencies are both, such as South Korea, which despite high private-sector debt offers strong government finances and strong trade.

For exporting economies, this will be unpleasant. Hot money inflows hurt exporters by pushing up the currency and the price of their exports. Already this year the Japanese yen has strengthened 5.6 percent against the dollar, prompting an abortive attempt by the Bank of Japan to push it back down. The Swiss franc has soared 21 percent, leading to talk that the Swiss National Bank may peg it against the euro.

Suppressing a currency's rise to protect exports, as China has been doing for years, is risky. It means creating more local currency and stoking inflation. Policymakers' response is often to raise interest rates, but that only attracts more hot money, creating asset price bubbles. Moreover, the unwanted effects of a strong currency pale next to the damage another U.S. recession would cause. In trying to frustrate the Fed, exporters could find themselves even worse off.