Why Currency Wars Are So Destructive
When a country chooses to devalue their currency a trading partner might retaliate, which could then leave both countries worse off.
When an economy starts to flag, governments may start a currency war. Investors need to know what this term means and also know why this can be so destructive to the countries that are involved.
This type of conflict starts when one country chooses to lower the value of their currency so that they are able to increase their exports. Exports will then become cheaper for foreign purchasers as their currency doesn’t deflate.
Lets say country 1 decides to devalue their currency by 10% against country 2. The exports from country 1 will probably surge because they are now cheaper. The issue though that these gains will come at the expense of country 2 as they will see their exports decline. Also in country 2 domestic sales may suffer, as the imports from country 1 are cheaper.
The result is then that countries will retaliate and the country that first devalued their currency is no better off in terms of their currency advantage.
It is then worse for both countries. This is because investment dollars will now leave countries that have devalued their currency.
In 2015, China devalued their currency and they saw a huge outflow of capital, so did other emerging markets. This type of capital is vital for the long-term growth of an economy, when it leaves, the country will grow at a slower pace.
The capital will then flow to countries that have maintained the value of their currencies and trade between devalued countries will suffer.