Q&A: Is this a ‘currency war’ and does it matter?

Brazil’s Guido Mantega, the finance minister for the country with what has been called the world's most overvalued major currency, has been war mongering: an ‘international currency war’ has broken out, he says.

What is this war and who’s fighting it?

As they emerge from the downturn – and try to prevent a return to recession – many countries are turning to exports to fuel their economic growth. But their exports are more competitive if they have a weak currency as they are cheaper for importing countries.

Countries including China, Japan, South Korea and Taiwan have all tried to weaken their currencies. Even our own central bank governor Mervyn King has said a fall in sterling would be 'helpful' in rebalancing the UK economy as we could do with an export-led recovery of our own.

Unfortunately it is relative – we can’t all boast a weak currency. And those countries with a trade deficit, where imports exceed exports, will suffer.

This is what led Mantega to issue his warning just last week.

Who are the main culprits?

Japan’s currency, the yen, hit a 15-year high against the dollar yesterday, making its exports more expensive.

The country’s central bank has taken action several times, selling yen and buying dollars to try to bring down the value of the yen.

The rising value of the yen, coupled with chronic deflation, prompted the country’s central bank to take action this week, with a three pronged plan to weaken the yen and improve the economy. 

But it is Japan’s neighbour China that has taken centre stage in the ‘currency war’ in recent weeks with tensions between the US and China steadily rising.

What’s being done about it?

There have long been critics of China’s currency manipulation – it is ‘stealing’ US jobs they say – but its domestic economic woes have prompted the US to take a tougher line.

The US House of Representatives passed a bill to levy tariffs on goods from countries that are undervaluing their currencies. Largely seen as a political measure ahead of the mid-term elections, the bill is aimed at China.

China in turn has described the bill as ‘protectionism’. Wen Jiabao, the Chinese prime minister, cautioned that a sharp rise in the yuan could have disastrous consequences for its exports and subsequently further afield: ‘If China saw social and economic turbulence, then it would be a disaster for the world,’ he said.