Currency War Brewing in 2011?

A few days ago Brazil’s Finance Minister Guido Mantega said that his country will continue to implement measures to keep the Brazilian real from rising and consequently hurting its exports. He also warned that a currency war could happen if other emerging economies follow suit. Uh-oh!

Simply put, a currency war happens when countries compete to devalue their currencies. Why would they do that, you ask? In Brazil’s case, Guido and his compadres don’t want the real to be too strong because it would make the country’s exports relatively more expensive to those of its competitors.

The plan is to tattletale to the World Trade Organization (WTO) and other international authorities about the issue of currency manipulation and push for rules to be implemented. He cited the U.S. and China being among the worst bullies.

Just to give you a little backdrop, currencies of emerging nations were on a roll in 2010, as massive inflows of “hot money” poured into their economies. In fact, emerging nations grew by a rate of just over 7.0% last year, while some of the favorite Western nations only grew by 2.7%. With so much capital flowing into these nations, it has caused their currencies to spike up in value.

Of course, the side effect of this is that they hurt export industries, while also potentially creating asset bubbles down the road.

In order to counter the capital inflow, emerging nations have stepped up in their efforts to keep their currencies at more “acceptable” levels.

Brazil has repeatedly stepped into the markets to try and curb the appreciation of the real, which has risen by 13% against the dollar over the past 7 months. Word in the Amazon (the jungle, not the website) is that Brazil has spent over 40 billion USD to intervene in the markets. Other moves include raising taxes on foreign purchases of Brazilian bonds and establishing a higher reserve requirement for domestic banks that hold foreign currencies.

Meanwhile, emerging South East nations like Singapore, Thailand, and Indonesia reportedly also dabbled in currency intervention in 2010. Looks like everyone is present at the currency manipulation party!

Recall that global markets have put China on the hot seat over actively intervening to keep the value of the renminbi low. Meanwhile, the U.S. has also been indirectly controlling the value of the dollar with its quantitative easing programs, which essentially increases the money supply in the U.S.

And now to the gazillion-dollar question – will currency and trade manipulations become one of the trending topics in 2011?

With so many economies manipulating their currencies, it’s only a matter of time before one of those G20 meetings produce a clear meaning of what exactly is a currency manipulator. When that time comes, will the title come with a good or bad reputation? Let’s hope we find out soon!

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