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Peruvian sole
Peruvian sole

-Analysis-

SANTIAGO - While Argentina and Venezuela have had to devalue their currency as a result of rampant spending and foreign exchange shortages, the rest of Latin America faces exactly the opposite problem.

Local currencies have appreciated against the dollar, which has had three negative effects. It is bad for exports; economies have become less competitive in foreign markets; cheap imports have invaded local markets.

The Chilean peso is the currency that has appreciated the most against the dollar in recent months, but then again, so have the Peruvian sol, the Colombian peso and the Mexican peso. During the global financial crisis of 2008, it was the Brazilian real that appreciated the most; to the point that many analysts said that in 2010 it had become the most overvalued currency in the world.

This was when Brazilian Finance Minister Guido Mantega accused the U.S. of starting a “currency war,” after the Federal Reserve announced its first round of “quantitative easing” and began to purchase tons of government bonds with newly issued money. Today, the Fed is in its third round, purchasing $40 billion of mortgage-backed securities every month, with the dollar dropping against major currencies.

Similar programs in Japan and the UK are devaluing the yen and the pound, adding to claims that the developed world has ignited a currency war. These claims were discussed in the G7 and G20 meetings this week.

However, there is no such currency war. The phrase is wielded against the U.S. (and Japan and the UK) because such talk attracts media attention and brings back memories of a historical cataclysm. The only real currency war occurred in the 1930s, when the U.S. and European countries began to devalue their currencies one after the other and one against the other – with the aim of promoting exports and limiting imports. This led to protectionism and the collapse of trade and the inflation and depression of the 1930s that brought the Nazis to power in Germany.

During a currency war, countries devaluate their currency in order to sell more to others and buy less from them.

Making a terrible mistake

The recent moves by the Fed, the Bank of England and the Bank of Japan seek to stimulate stagnant economies via keeping interest rates low, boosting consumption and investment. All three central banks resorted to quantitative easing because they could no longer lower their interest rates and emitting bonds to buy them was the only resource they had left.

By keeping interest rates low to stimulate domestic consumption and investment, the central banks also drive down the price of their currency. As these countries emit more money, investors abandon the dollar, the yen and the pound to go buy securities from countries with higher rates and stronger currencies.

Yes, developed countries’ use of quantitative easing has had the side effect of making successful Latin American currencies more expensive, undermining their trade balance. But its primary effect is to make developed economies grow, and this in turn makes all economies grow. Also, this makes international capital flow toward countries with high interest rates, such as is happening in the Latin American economies.

This sounds good, but it is not enough to convince the Finance Ministers of Brazil, Chile, Peru and Mexico. Brazil was relatively successful in stopping the rise of its real in 2011 and 2012, but the planned slowdown of its overheated economy has been too severe, and in recent months has fuelled inflation. Markets are now predicting that Brazil will let the real rise again in order to cheapen imports and tame inflation.

Latin America’s market economies have the largest growth rates today. Finance Ministers of Chile, Peru, Colombia and Mexico have joined Brazil and started complaining that the depreciation of the dollar is hurting their exports. But their central banks would be making a terrible mistake if they react to all this talk of currency wars by devaluating their currencies to defend their exports. Doing so would turn "talk" of a currency war into the real thing.

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