Currency Wars_ The Making of the Next Global Crisis - James Rickards [22]
Protectionism is not limited to the imposition of tariffs but may include more severe trade sanctions, including embargoes. A notable recent case involving China and Japan amounted to a currency war skirmish. China controls almost all of the supply of certain so-called rare earths, which are exotic, hard-to-mine metals crucial in the manufacture of electronics, hybrid automobiles and other high-tech and green technology applications. While the rare earths come from China, many of their uses are in Japanese-made electronics and automobiles. In July 2010, China announced a 72 percent reduction in rare earth exports, which had the effect of slowing manufacturing in Japan and other countries that depend on Chinese rare earth supplies.
On September 7, 2010, a Chinese trawler collided with a Japanese patrol ship in a remote island group in the East China Sea claimed by both Japan and China. The trawler captain was taken into custody by the Japanese patrol while China protested furiously, demanding the captain’s release and a full apology from Japan. When the release and apology were not immediately forthcoming, China went beyond the July reduction in exports and halted all rare earth shipments to Japan, crippling Japanese manufacturers. On September 14, 2010, Japan counterattacked by engineering a sudden devaluation of the Japanese yen in international currency markets. The yen fell about 3 percent in three days against the Chinese yuan. Persistence by Japan in that course of devaluation could have hurt Chinese exports to Japan relative to exports from lower-cost producers such as Indonesia and Vietnam.
China had attacked Japan with an embargo and Japan fought back with a currency devaluation while both sides postured over a remote group of uninhabited rocks and the fate of the imprisoned trawler captain. Over the next few weeks the situation stabilized, the captain was released, Japan issued a pro forma apology, the yen began to strengthen again and the flow of rare earths resumed. A much worse outcome had been avoided, but lessons had been learned and knives sharpened for the next battle.
A prospective currency warrior always faces the law of unintended consequences. Assume that a currency devaluation, such as one in Europe, succeeds in its intended purpose and European goods are cheaper to the world and exports become a significant contributor to growth as a result. That may be fine for Europe, but over time manufacturing in other countries may begin to suffer from lost markets leading to plant closures, layoffs, bankruptcy and recession. The wider recession may lead to declining sales by Europeans as well, not because of the exchange rate, but because foreign workers can no longer afford to buy Europe’s exports even at the cheaper prices. This kind of global depressing effect of currency wars may take longer to evolve, but may be the most pernicious effect of all.
So currency devaluation as a path to increased exports is not a simple matter. It may lead to higher input costs, competitive devaluations, tariffs, embargoes and global recession sooner rather than later. Given these adverse outcomes and unintended consequences, one wonders why currency wars begin at all. They are mutually destructive while they last and impossible to win in the end.
As with any policy challenge, some history is instructive. The twentieth century was marked by two great currency wars. The first, Currency War I, ran from 1921 to 1936, almost the entire period between World War I and World War II including the Great