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Why Winning The Currency War Has Its Consequences
Perspective | 06 May 2013
By: Kathy Lien
Articles (9) Profile

This article contribution is written by Kathy Lien, Managing Director of FX Strategy at BK Asset Management

You may have heard the term “Currency War” and the idea that countries around the world are competing against each other to achieve a lower currency value through easy monetary policy. Last week, the European Central Bank kick started a new round of stimulus by cutting interest rates 25 basis points or 0.25% and the month before that, the Bank of Japan announced an aggressive plan to reach their 2% inflation target through bold and intense asset purchases. Other central banks around the world are also considering easing as everyone believes that a weak currency will be the ultimate savior for their economies. In many ways, they are right as there are many benefits to a lower currency:

Benefits Of A Weak Currency

1. Increased Exports
The primary benefit of a lower or weaker currency is that increases the competitiveness of a country’s exports. Since Singapore is a net importer of U.S. products, let’s imagine that the U.S. dollar declines in value. So previously 1 U.S. dollar bought 1.30 Singapore dollars and now it only buys 1.25 Singapore dollars. This means it costs less for Singaporeans to buy U.S. goods and if the devaluation was caused by U.S. monetary policy. The hope from the Fed is that a weaker U.S. dollar will encourage Singaporeans to buy more U.S. goods. A lower currency also keeps U.S. demand domestic because it makes the cost of foreign goods less competitive and more expensive. Over the medium term, this benefits corporations, which can eventually translate into more jobs and consumer spending as well as a lower trade deficit.

2. Foreign Investment
A lower currency can also make merger and acquisitions more attractive. An Australian company for example may look at a weakening New Zealand dollar as a reason to invest or acquire a New Zealand company. Even on a smaller scale, a Singaporean investor may look at a weaker Australian dollar as a reason to increase their holdings of Australian shares because on a relative basis, the cost of the share has declined because of currency changes.

3. Increased Tourism
A weaker currency is extremely advantageous to tourism, which is good for any economy. In many major economies, tourism is very important because it can contribute to employment and growth for many industries.

4. Profitability For Companies
Meanwhile multinational companies with high foreign revenue benefit the most from a lower currency because their foreign currency revenue will be higher in value when they repatriated (brought home), not because they sold more goods, but because they earn more from currency conversion.
But winning the currency war can also have its consequences.

Consequences Of A Weak Currency:

1. Higher Costs For Foreign Goods
The most immediate disadvantage of a lower currency is the increased costs for foreign goods. It is no secret that in many developed economies, consumers import far more than they export. So a weak currency increases the cost of imports. A country like Singapore imports heavily from other countries and a weaker Singapore dollar would make imports more expensive and for certain goods that are not made domestically, it is cost that may be unavoidable.

2. Inflation
The main problem with a weaker currency is that higher costs for foreign goods increase inflation or price pressures. Although inflation is not a huge problem at the moment for most countries, one day they could be which could prompt central banks to retract monetary stimulus sooner than they might otherwise anticipated.

3. Foreign Travel Is More Expensive

On a consumer level, the weakness of a currency makes foreign travel more expensive. If for example let’s imagine that the euro weakened 20 percent against the Japanese yen. This means that due to nothing other than currency fluctuations, travel to Japan has become 20 percent more expensive for Europeans.

4. Reduced Profitability For Importers
Finally companies that import a lot of goods or have significant expenses in foreign currencies can also be hurt by a weak currency. For example, if a European company owed a US company USD$1 million in account payables and the EUR/USD was trading at 1.50, the USD$1 million would be worth an equivalent of EUR 666,666.67. However, at 1.20, the same USD$1 million would be worth EUR 833,333.33. The risk can be mitigated by hedging but not all companies hedge their currency exposures properly and completely.

As countries around the world are engaged in a currency war, it is important to remember that while there are many benefits, participating let alone winning the currency war can also have its consequences.

Kathy is a well-known expert in the Forex world and has over 10 years of trading experience in the forex market. She is frequently seen and quoted on international media platforms such as CNBC.

Please click here for more information about this author.

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