Lose-lose

Currency wars pose disinflation risk for losers

The dollar and the euro are rising against a range of currencies, and particularly some emerging ones. It makes US and Euro zone exports more expensive, and imports cheaper. They can absorb the trade hit. But with inflation already worryingly low, the downward pressure on prices might be harder to take.

The trade-weighted indexes of the dollar and euro have both risen about four per cent in the past year. The measure is dampened by how the two currencies have moved against each other: the euro is up only 1.7 per cent against the dollar. But there have been big falls against the currencies of countries with more expansive monetary policy and those under pressure from international investors. The yen has dropped nine per cent against the dollar in the past 12 months, while currencies in Argentina, Brazil, Chile, India, Indonesia, Philippines, Russia and Thailand have fallen between eight and 36 per cent.

Such swings don't affect commodity exports which are priced in dollars. But the dollar or euro cost of anything with a local currency price tag will fall, as long as exporters in countries with depreciating currencies decide to pass through their new cost advantage. Sometimes producers prefer to pocket higher profits.

In any case, the direction is clear; stronger currencies point towards lower prices. That may be good news for American and European consumers, but it is just about the last thing monetary policymakers want.

Both the US Federal Reserve and the European Central Bank are struggling with inflation rates well below their two per cent target. They profess not to be worried about persistent disinflation. However, downward pressure from imports only makes their job harder.

Weak currencies are not always welcome. For developing countries in normal times, a strong exchange rate is a sign of development. However, when so many are engaged in competitive devaluations, a strong currency is the mark of defeat. For the United States and the Euro zone, the loss of trade competitiveness may not be the worst effect of the global currency war.