A currency war is raging across the world, as foreign central banks ease policy to devalue their currencies and boost exports. And Mohamed El-Erian, chief economic adviser at Allianz, says the war might last for a while.
"Not all currencies can depreciate against one another at the same time. But the current wave of efforts, despite being far from optimal, can persist for a while, so long as at least two conditions are met," he writes in an article for
Project Syndicate.
"The first condition is America's continued willingness to tolerate a sharp appreciation of the dollar's exchange rate." The greenback has reached multi-year highs against many currencies in recent weeks.
Given the strong dollar's harm for U.S. companies and our trade balance, "this is not guaranteed," El-Erian says. "Still, as long as the U.S. maintains its pace of overall growth and job creation — a feasible outcome — these developments are unlikely to trigger a political response for quite a while."
The second condition is "financial markets' willingness to assume and maintain risk postures that are not yet validated by the economy's fundamentals," El-Erian writes. "With central banks pushing for increasingly large financial risk-taking, this is no easy feat," he adds.
"Central banks will have to back off eventually. The question is how hard the global economy's addiction to partial monetary-policy fixes will be to break — and whether a slide into a currency war could accelerate the timetable."
David Woo, head of global currency research at Bank of America Merrill Lynch, is concerned about the currency war too. "At this point, FX volatility has become the prime driver in global volatility," he says, according to
CNBC.
Indeed, currency volatility has hit a 20-year high for non-crisis periods by BofA's calculations. "You cannot make any investment decisions without actually understanding which way the dollar is heading," Woo says.
The war is self-sustaining. "If everyone's playing this game you have no choice but to play it, because otherwise you get left behind," Woo explains. "We call it war because it's a zero sum game. Somebody wins, and somebody else loses."
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