The Science Scholar

The ongoing currency war

By Cielito Habito
Philippine Daily Inquirer
First Posted 05:09:00 10/05/2010

Filed Under: International (Foreign)Trade, Central Banks, Markets & Exchanges

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WONDER WHY the peso-dollar exchange rate keeps going down? It has broken into the P43 peso range, and could continue getting lower. If you are happy with that, then you probably buy a lot of imported goods, or travel abroad a lot, or invest a lot overseas. But if you work in an export or tourism-oriented business, maintain a foreign currency account, or depend on a family member’s remittances from abroad, you must be quite unhappy with what’s going on. If you’re working for a firm that doesn’t export but produces goods for domestic consumption, you may not be feeling it directly—yet. But trust me, you are bound to get hit as well, as competing imports get cheaper and price your own product out of the market.

The international economic news is lately dominated by the ongoing international currency war, as first publicly lamented last week by Brazil’s finance minister, Guido Mantega. Before him, nobody seemed to want to use the “W” word publicly. Economists have a more technical term for it, calling it “competitive depreciation,” and have been warning against it since the global economic crisis began two years ago. Simply put, central banks all over the world are taking measures to deliberately make their currencies cheaper. Translation: they are moving to make their domestic-foreign exchange rates go higher. But as they do so, they induce a chain reaction among central banks, putting them on a treadmill that makes it difficult for them to stop.

How exactly do the central banks do it? We don’t have to look far: our own Bangko Sentral ng Pilipinas (BSP) has also been forced to do it lately. It has been buying up from the open market large amounts of foreign currency, especially dollars, to try to drive up its price (or what is the same thing, drive the peso value down). This also means that it releases a lot of pesos—i.e., those it uses to buy dollars—into the system. With the law of supply and demand, the price of dollars goes up as the BSP itself has added to the demand for it. Equivalently, the value of the peso goes down, because the BSP has increased the supply of it in the market. At the extreme, a central bank may actually decide to fix the exchange rate at a lower level regardless of market forces. But at this day and age, few would defy the law of supply and demand, and would much rather just influence one or the other.

So if the BSP has been doing this, why has the peso-dollar exchange rate still moved down? This is where the currency war comes in and complicates matters. In economic briefings I had given in past months, I suggested that the exchange rate would not move dramatically from the P45-46 range we were seeing some months back. This was because the pressures that tend to weaken the peso, like oil and commodity price increases and high government deficits, offset the pressures that tend to strengthen the peso, especially the continued weakening of the US dollar. What I did not factor in then was the likelihood of a currency war, as is transpiring now. Closer to home, the central banks of Japan, South Korea and Taiwan recently moved to make their currencies cheaper. Central banks elsewhere are doing the same. But with that, countries will only find themselves exactly in the same place before they began intervening to cheapen their currency. And the pressure to intervene will continue, inducing a continuous race to the bottom.

Key to all of this is China, which for years has been accused by the US of manipulating the yuan to keep its value artificially low. With China exporting so much more to the US (and the rest of the world) than it imports from them over the years, the value of the Chinese currency should be much higher than it has been—as much as 20 percent higher, according to estimates. But China is accused of effectively taxing its imports and subsidizing its exports through this cheap yuan policy. China does this by buying and accumulating large amounts of US dollars in cash and government bonds; it now has more than $2.4 trillion in dollar reserves. What the US wants is for China to unload those dollar holdings, thereby buying back yuan, which will raise the demand for it and thus raise its value.

To put pressure on the Chinese, the US Congress passed legislation last week that would put heavy tariffs on American imports from China. But others fear that this will only push the Chinese to hit back by putting similar stiff restrictions on American goods and investments entering China. And judging from China’s statements and actuations in recent years, any significant move to let their currency rise substantially in value is not in the offing. And so, the Chinese currency continues to be deliberately kept weak, while its major trading partners like the US, Japan and Europe are driven to defensively do the same.

So where do all of the investible funds go to take refuge? To countries like the Philippines and its neighbors whose currencies get stronger when the major economies’ currencies get weaker, of course. And as all the hot money surges in, the peso gets even stronger.

Of course, if you were a government official who didn’t know better, you would be happily and proudly taking credit for our “strong peso,” claiming that it is proof that our economy is being managed well (we saw a lot of those in the past administration). Our Bangko Sentral, of course, knows better.

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Cielito Habito (PSHS Batch 1970): Former Director General of the National Economic and Development Authority; ; Gawad Lagablab Awardee (1991)
E-mail: cielito.habito@gmail.com