Op-Ed: War, What is it Good For?

op-ed-pro-featured-image.jpg

By Joe Kearns

When the Greek king Pyrrhus suffered heavy casualties in a victorious battle, he remarked, “If we are victorious in one more battle with the Romans, we shall be utterly ruined.” Similarly, as central banks in Europe, Australia, Japan, India, Vietnam, and other economies weaken their currencies against other nations, the economic costs could be disastrous. It is in each central bank’s self-interest to lower interest rates to stimulate domestic growth through a more favorable trade balance. Yet, Bank of America Merrill Lynch strategist David Woo warns of the danger of this currency war: “if everyone is playing the same game, all we will end up with is more and higher [foreign exchange] volatility.” Thus, the only gains from this war will be Pyrrhic victories.

The risks of FX volatility arising from depreciating currencies have grim implications for international trade in goods and capital. Higher FX volatility increases the riskiness and cost of cross-border transactions, along with the costs for investors who hedge currency exposure. Uncertainty gives firms an incentive to focus on their home countries, resulting in weaker international trade and slower global economic growth. According to Woo and fellow BAML strategist Vadam Iaralov, this chain of events is foreseeable because current FX volatility is at its highest level since the financial crisis in 2008. Incidentally, uncertainty in the aftermath of the financial crisis produced the steepest global trade decline since World War II. The looming economic threat lies in the irony that humans are averse to risk amidst uncertainty that produces the outcome they wanted to avoid.

A major pitfall of a currency war is that an economy is susceptible to lose even if it does not participate in it. U.S. corporate earnings have taken a hit, as nearly every currency depreciated against the dollar in 2014. American companies like Procter & Gamble, Johnson & Johnson, and Pfizer reported hits in their earnings because foreign revenue translated to fewer dollars. This predicament could worsen if the Federal Reserve raises interest rates later this year, as Barclays Capital economist Michael Gapen predicts. The trap of currency wars has been laid for combatants and bystanders alike. Onward, march!

Editor's Note: This piece is one of two op-eds framed around the question, "Will the currency wars do more harm than good?"  It takes the affirmative position. To read the opposing view, please read, "(Not) Absolutely Nothing!" by Cole Lennon.

Read More:

http://cnb.cx/1MaxYd9

http://on.wsj.com/1uBqE4E

http://nyti.ms/1zIeQxP

http://usat.ly/1zpYkEB