Project Description

CHAPTER ONE:
INTRODUCTION
1.1 Background to the Study
Whenever we think of war, it is easy to imagine the involvement of soldiers and the presence of guns, tanks weapons of mass destruction etc. and a chaotic war situation. In another stead, when we think of trade transactions, exchange rates, currency and currency policies, it becomes difficult to think of war because they are instruments of economics. But in a situation whereby countries use currency as weapons during conflict, it is referred to as „Currency war‟. The term “currency war” was coined in September 2010 by the then Brazilian Finance minister Guido Mantega, who first raised the eyebrow of the public about the currency war. It is a new terminology that is used in place of “competitive devaluation” of international currencies. According to general economic studies, competitive devaluation refers to a condition in international affairs where countries compete against each other to achieve relatively low exchange rates for their respective currencies, as the price to buy a particular currency falls so does the real price of exports from that country (Burda and Wyplosz, 2005). Although imports become more expensive, the domestic industry as well as local employment receives a great boost as a result of preference of the citizens for locally produced goods (Brown, 2010). However, consistent devaluation of currency on the long run could harm the purchasing power of the citizens and could provoke and trigger retaliatory action by other countries which in turn can lead to a general decline in international trade thereby harming all countries. Basically, in competitive devaluation, a country only gains temporary advantage until the next country devalues its currency exchange rate as well.
In the past, competitive devaluation has been rare throughout most of history because countries have generally adhered to maintaining a relatively high value for their currencies (Cooper, 1971:3). It was rare for governments to intentionally devalue their currencies. Even for countries with low levels of unemployment, it was more common to consider a strong currency as the rational choice. However, in the 1930s, currency war broke out during the great depression, when countries abandoned the use of Gold standard for exchange rate and preferred to use devaluation in pushing up their economies by competing and exporting unemployment to their trading partner countries, the concept which was then known and referred to as “Beggar thy Neighbor” (Rothermund, 1996: 6-7). Beggar thy neighbor is seen as an economic policy in which one country attempts to remedy its economic problems by means that tend to worsen the economic problems of other countries. Since devaluation effectively increased unemployment overseas, the trading partner countries equally retaliated with their own devaluations which in turn led to reduction in overall international trade.
Some economist observers have however argued that the China‟s intentional or unintentional maintenance of the value of the Yuan was traceable to the Asian crisis of 1997 during which the foreign reserves of the Asian economies ran seriously low and led them to accept low prices for their commodities, assets and to also receive harsh terms by the IMF (Accominotti, 2011). The free market had failed the Asians, implying that they had to seek solution by keeping the value of their currencies low (Wolf, 2009: 31-39). The strategy encouraged export-led growth and at the same time built up the Asians foreign exchange reserves in protective anticipation of any future crisis. It argued that the currency war did not exist at this point because the advanced economies, such as the United States, were happy and contented with the strategy because the strategy benefited their citizens who were able to purchase cheap imports of high material from Asia and enjoy high standard of living (Reinhart, 2010: 208-212). This advantage made the United States partially oblivious to the fact that their current account deficit was growing at a substantial pace, because the collective view of the U.S free market economists and policy makers like the then Chairman of the Federal Reserve Alan Greenspan and US Treasury Secretary until 2007 was that deficit was not a major problem to worry about (Roubini, 2004).
Although there had been some voiced complaints in 2005 by the United States Trade Union along with US executives and officials at the intermediate level about perceived unfair trade actions by China, the international economy was then still in good shape, China abandoned the currency peg (fixed exchange rate system), allowed its currency (Yuan) to appreciate substantially and at the same time increase its exports until 2007. In 2007, financial crises began to reduce China‟s export orders as such the dollar peg was re-established. This is what Economists like Michael P. Dooley, Peter M. Garber and David Folkerts-Landau described the relationship between the US and the emerging economies as the Bretton woods II. The period from the end of the 2nd world war until about 1971 was known as Bretton Woods. This was characterized by a system of semi-fixed exchange rates which meant that competitive devaluation was not an option, which was one of the design objectives of its creators. In addition, global economic growth was generally high in this period thereby removing any incentive for currency war even if it had been possible (Ravenhill, 2005). Thus with the re-establishment of China‟s currency peg, there is the assumption of a currency war that will exist between the United States and China, with implications on global economy.

1.2 Statement of Problem
The United States of America – China economic relationship is entangled in the currency issue and trade balance between the two countries. China‟s path-breaking reforms have successfully transformed them from a poor closed nation to a state to be reckoned with economically. The rapid rise of the Chinese economy in recent years is creating opportunities for many and causing increasing trade disputes with its major trading partner; United States. China is being accused of using protectionist policies by constantly maintaining an undervalued exchange rate to boost her competitive advantage in the international market and also accumulating its foreign exchange reserves at the detriment of the United States. The United States have expressed considerable concern that by undervaluing its currency, China is gaining an unfair advantage and has seriously crippled their manufacturing sector.
The United States in turn is using policies like Quantitative easing by printing and injecting money into the domestic economy through market operations. The newly injected money is possibly destroyed after the economy becomes better in order to prevent inflation. Although the United States administration denied that the purpose of implementing quantitative easing was not to devalue the dollar, the policy can act as medium of devaluing a country‟s currency (Mackintosh, 2010). Subsequently, it has become a competition about who has the lesser value for her currency which invariably leading to currency war. In the same vein, just like during the great depression of the 1930‟s, it could lead to the general decline of international trade because a currency war between the two largest economies can and will affect the economy of other nations within the international system. It is then against this backdrop, that this study seeks to examine the issue of currency war between China and United States and the major implications on the global economy.

1.3 Objective of Study:
 To examine the issue of currency war between China and USA.
 To identify the causes of the currency war between China and USA.
 To analyze the implications of the currency war between USA and China on both countries.
 To analyze the implication of currency war on global economy.
1.4 Research Questions:
 What is currency war? And how does it exist between China and USA?
 What are the causes of the currency war between China and USA?
 To what extent has the currency war affected China and USA?
 To what extent has the currency war affected the global economy as a whole?
1.5 Significance of Study:
 The study will be useful to scholars, researchers and analysts of international relations because it will help them locate the causes of currency war and also to help in proffering workable solutions or minimize the impacts

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