currency

In the 1930s, Great Britain, France and the United States tried to stimulate their economies by competitively devaluing their currency in what’s now known as “a currency war.”

With world economies once again suffering from a downturn, many market watchers have been weighing in recently on whether we’re in the midst of another such war, where countries aim to help their export sectors and raise import prices by devaluing their currencies.

What’s my take? I agree with the head of the International Monetary Fund who back in February said that talk of a currency war is “overblown.”

While the currencies of many developed countries have been weakening in recent years, this is not due to countries maliciously trying to drive down their currencies relative to those of targeted neighbors. Rather, it’s merely a byproduct of central banks in the United States, the United Kingdom and Europe going to extraordinary lengths to spur economic growth and in the case of Japan, central bank efforts to exit a deflationary spiral.

With interest rates already low, the central banks are turning toward unconventional accommodative monetary policy such as quantitative easing, which has resulted in a dramatic increase in the monetary base levels and as a result, weaker local currencies.

In short, while the goal of such monetary policy is not a weaker currency, a weaker currency is a very normal side effect and central banks obviously understand this and are willing to live with it for the same reason they’re trying to drive both long- and short-term interest rates down.

So what does this mean for investors? As central banks aren’t likely to end their stimulus efforts anytime soon, investors should expect more exchange-rate volatility in the months ahead. In addition, dollar-based investors in certain markets, most notably in Japan, may want to hedge their exposure to weaker local currencies in order to potentially hold on to more local market gains.

Source: Bloomberg, Reuters

Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.