Currency Wars

It starts innocently. You just try to weaken the currency a little to make exports more competitive and to boost the economic growth. You intervene directly in the foreign exchange market, cut interest rates or engage in quantitative easing, just to improve a bit your economic position on the global stage. But before you know it, other countries do the same and you are in the middle of currency wars.

What are they? Currency wars, also known as competitive devaluations, are a situation when a number of nations seek to deliberately depreciate the value of their own currencies to stimulate their economies. So, it is a tit-for-tat escalation of currency devaluations where each country aims to improve its economic position at other countries’ expense. But the problem is that it is impossible for all countries to weaker their currencies and stimulate their exports and growth at the same time. If one currency is getting weaker, others are getting relatively stronger. This is why the currency wars are also known as “beggar thy neighbor” – the policy of currency devaluation negatively affect other countries.

Gold and Currency Wars

What is the link between currency wars and gold? In theory, currency wars should be positive for gold prices. This is because they hamper the long-term economic growth – and precious metals shine the most during slowdowns or recessions. The currency wars also disturb international cooperation, increasing the geopolitical risks. It should decrease the risk apetite, supporting the safe-haven assets such as gold.

History shows that currency wars increase the odds of military conflicts. In the 1930s, countries abandoned the gold standard during the Great Depression and started to devaluate their currencies in an attempt to stimulate their exports. However, trading partners quickly retaliated with their own devaluations, leading to chaotic changes in exchange rates, which reduced the overall international trade. Combined with the trade wars, the currency wars from the 1930s led to the rising protectionism and autarky, contributing to the outbreak of the WWII.

Moreover, competitive devaluations of fiat currencies decrease their value against gold – the ultimate currency. Competitive devaluations increase also Inflation, increasing the demand for gold as an inflationary hedge.

However, in practice, gold does not always go up in times of currency wars or when markets worry about the outbreak of currency wars. As the chart below shows, although gold rallied in 2010-2011, when markets were turbulent after former Brazilian Finance Minister Guido Mantega warned in September 2010 that an international currency war had broken out, it remained in the bear market in 2013 when markets worried about Japan’s competitive devaluation.

Chart 1: Gold prices during concerns about currency wars in 2010-2011 and 2015.

Currency Wars and Gold Chart