“The Fed is firing a volley in a destructive international currency war.” This is the criticism that has come from some of our trading partners: in particular, China, Germany and Brazil. I don’t generally do “My country, right or wrong.” But my country is right on this one. Monetary easing is not a beggar-thy-neighbor policy. The colorful phrase “currency wars“ seems to have confused some people. The current situation is precisely the point of floating exchange rates: when some countries feel that their high unemployment calls for monetary expansion (US) at the same time that others feel that their overheating calls for monetary tightening (Brazil, India, Korea, China…), an appreciation of the latter currencies against the former is precisely the way that floating rates accommodate the differences. This is why Milton Friedman favored floating rates, so that each country could pursue its own desired policies independently. I realize that the pressure which US monetary easing puts on countries like China to allow appreciation is unwelcome. China is finding it increasingly difficult to cling to its exchange rate target by means of controls on capital inflows and sterilized foreign exchange intervention. But capital flows are a far more legitimate way to let China feel the pressure than the alternative: Congressional threats to impose WTO-inconsistent tariffs on Chinese imports if it won’t allow faster appreciation of the yuan.
This is a topic I have wanted to tackle for some time.
When Brazil first made the allegation that the Fed's Quantitative Easing program was creating a "global currency war" certain financial bloggers picked up on the idea and ran with the "we're all going to die" meme. Unfortunately, nothing could be further from the truth.
Brazil's currency is rising for several reasons.
1.) High interest rates. Brazil's interest rates are over 11% -- a rate of interest that will attract currency traders to the Real because these rates are some of the highest in the world. Brazil will be increasing their rates going forward, largely because of domestic inflationary pressures.
2.) A growing economy. Brazil was remarkably untouched by the recession. In fact, it has been growing at strong rates for some time, making it a natural magnet for investment, which causes its currency to appreciate in value.
3.) Brazil is a natural resources economy -- especially after the Brazilian oil company announced it made a major find off the coast of Brazil -- which will also attract investment.
All three of these factors are a prime reason for the Real's appreciation, which means the argument that we're in the middle of a "currency war" is misplaced.
