Root causes behind the Currency War Crisis

In today’s floating exchange rate era, nations can manipulate monetary tools such as lowering interest rates or quantitative easing (QE) to depreciate their currency. Still, these tools may backfire, leading to hyperinflation or diminished investor confidence.

Currency wars are not merely economic issues; they are also deeply political. They reflect power struggles on the international stage and are closely watched by economists, policymakers, and global markets alike.

How Does a Currency War Start?

Currency wars typically arise during times of economic recession, when domestic consumption plummets due to high unemployment, rising debt, and reduced purchasing power. As citizens cut back on spending, businesses pull back on production and investment, leading to further economic stagnation.

A country’s GDP comprises household spending, government expenditure, business investment, and net exports. In times of economic decline, boosting household or business spending is often unfeasible, and raising taxes may worsen the problem. The most viable solution is to increase net exports.

To do this, a country might choose to devalue its currency, making its products cheaper and more competitive on the global market. The strategy: increase exports, attract foreign currency inflow, and stimulate the domestic economy. However, this can harm other countries’ economies, prompting retaliation such as import tariffs or anti-dumping penalties.

A Classic Example of a Currency War

To better understand currency war in action, consider this simplified scenario:

Originally, 1 kg of rice in China costs 10 CNY. With an exchange rate of 1 USD = 20 CNY, one US dollar could buy 2 kg of rice.

After devaluation, if the rate changes to 1 USD = 40 CNY, that same dollar now buys 4 kg of rice. The price of rice in China hasn’t changed locally, but it becomes significantly cheaper internationally, boosting China’s export competitiveness. As exports increase, Chinese manufacturers expand operations, generate jobs, and raise national GDP.

In this process, China essentially shifted its economic burden to other countries. In the US, cheaper Chinese goods displaced domestic products. To remain competitive, other nations were also forced to devalue their currencies — igniting a chain reaction that defines a currency war.

The 1930s global depression offers another example. As countries attempted to escape recession by devaluing their currencies, retaliatory actions led to widespread economic chaos.

Consequences of Currency Wars

Currency wars often leave lasting damage on economic, social, and political fronts. Key impacts include:

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• Rising unemployment: Businesses may cut costs by reducing staff as they race to stay competitive.
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• Trade disruptions: Protectionist policies emerge, limiting international cooperation.
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• Inflation: Currency devaluation drives up the price of essential goods and services.
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• Financial instability: Investors may lose confidence, leading to reduced capital flow and stock market losses.

One of the most significant financial crises linked to currency wars is the Global Financial Crisis of 2008. During the 1990s, the U.S., Japan, and Europe cut interest rates aggressively to stimulate growth, fueling a housing boom. But by 2001, the 9/11 attacks triggered major market disruptions.

In response, the U.S. reduced interest rates to near-zero levels, ushering in an era of cheap money. This created an overheated real estate market. By 2007, housing prices plummeted, mortgage-backed securities collapsed, and Lehman Brothers filed for bankruptcy in 2008 — sparking a worldwide recession.

The Human Cost of Currency Wars

Currency wars don’t just affect governments and markets — they hit everyday people the hardest:

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• Mass layoffs due to factory closures and budget cuts.
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• Soaring living costs as inflation makes basic goods more expensive.
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• Investment losses as stock markets crash or remain unstable.
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• Reduced savings and future investments due to declining asset values.

Currency devaluation can also make foreign debt repayments more expensive and erode a country’s international purchasing power. Politically, it can increase tensions and complicate diplomatic relations.

While a weak currency can boost exports, it also diminishes citizens’ ability to purchase imported goods, making government-led devaluation strategies unpopular.

Historic Currency Wars

First Major Currency War (1920s–1940s)

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• 1921: Germany initiated hyperinflation to stimulate its economy but lost control, devastating its financial system.
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• 1925: France devalued the franc to gain export advantage, attracting American consumers.
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• 1931: The UK abandoned the gold standard and devalued the pound.
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• 1933: The US joined the war by devaluing the dollar relative to gold, regaining lost trade competitiveness.

The first currency war ended post-WWII with the Bretton Woods Agreement (1944), where major powers agreed to fix exchange rates, pegging the USD to gold at $35/oz.

Second Major Currency War (1967–1985)

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• 1967: The UK printed more money than it had in gold, leading to the pound's devaluation.
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• 1973: The Bretton Woods system collapsed. Nations returned to floating exchange rates.
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• 1985: The US pressured G7 countries into the Plaza Accord, which aimed to reduce the dollar's value after it became too strong and hurt exports.

Recent Currency Conflicts

Besides the major wars, smaller-scale currency wars have emerged in modern times:

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• 2008: Following the Lehman Brothers collapse, the U.S. implemented quantitative easing, effectively devaluing the dollar. Japan similarly weakened the yen to boost exports.
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• 2010s: China floated the yuan, leading to record lows in its value. At the same time, China halted U.S. agricultural imports. In response, the Trump administration labeled China a currency manipulator and imposed trade sanctions.

These modern examples further prove that currency wars are not relics of the past — they continue to shape global trade and economic policy today.

Currency wars, while strategic on paper, often inflict severe damage on ordinary citizens and the broader economy. From unemployment and inflation to political instability and financial crises, the consequences are profound and far-reaching.

Although devaluing a currency can provide temporary export advantages, when multiple countries adopt this strategy, no one truly benefits. Instead, businesses and investors bear the brunt of disrupted trade and financial losses.

Understanding currency war dynamics is crucial to navigating a volatile global economy. At the end of the day, the ones who suffer most from currency wars are the people — workers, consumers, and entrepreneurs alike.