Stage set for worldwide currency war

The International Monetary Fund's latest outlook is framed against a backdrop of growing concern about the risk of a global currency war.

Japan last month intervened for the first time in six years to restrain the yen, while China is resisting calls to let the yuan rise faster. At the same time, a potential revival of US and UK asset-purchase plans may spark declines in their currencies.

UBS says the "mega-trend" of interventions will weigh heavy on the US$4 trillion ($5.3 trillion)-a-day foreign-exchange market for the next decade.

While lower exchange rates can lift an economy by helping exports, the danger is that the moves escalate into devaluations and protectionist retaliation, impeding global growth.

Brazil's Finance Minister Guido Mantega, a delegate to the IMF annual meetings in Washington this week, said last month that there was already a worldwide "currency war".

"There's a real danger of a more unilateral approach taking hold," said Mansoor Mohi-uddin, the Singapore-based head of global currency strategy at UBS.

"There will be more countries outright intervening and others inadvertently weakening their currencies."

Even as G-20 finance deputies meet in the US capital, followed by a G-7 ministers' dinner, officials aren't signalling a return to the currency accords of the 1980s.

Japanese Finance Minister Yoshihiko Noda said he was ready to explain his country's recent currency sales at the talks.

"All this serves to highlight the tensions building," said Simon Derrick, chief currency strategist at Bank of New York Mellon Corp in London. The camps are composed of "those who believe in the need for greater discipline in the currency markets and those who believe that official interference leads to ever increasing distortions", he said.

Tim Adams, the Treasury's top international official during George W. Bush's administration, says it's more of a currency "skirmish" than a "war" and is unlikely to end in policymakers trying to restore order as they did when the 1985 Plaza Accord weakened the US dollar and the Louvre Accord buoyed it two years later.

The G-7 hasn't intervened in a co-ordinated way since 2000, and its ability to influence the currency market has diminished as daily trading more than doubled from US$1.7 trillion in 1998.

Even if a modern version of the Plaza Accord isn't likely, direct or indirect forms of intervention will set the tone, causing a weaker US dollar and British pound, and buoying the Australian currency, as its central bank tolerates gains, said Mohi-uddin, 40, who predicted a new age of intervention in a May report.

Five months later, that forecast is panning out as the yen's rise to a 15-year high against the US dollar last month led Japan to sell its currency.

US Treasury Secretary Timothy Geithner yesterday said a "damaging dynamic" of large economies keeping their currencies undervalued could cause quicker inflation and asset bubbles, and restrict growth.

- BLOOMBERG