Are We on the Verge of a Currency War?

Generals (l to r): First deputy chairman of Russia’s central bank Alexei Ulyukayev, Luxembourg Prime Minister and the president of the group of euro-zone finance ministers Jean-Claude Juncker, Federal Reserve Bank of St. Louis President James Bullard, and Bank of England Governor Mervyn King. (Images courtesy Getty Images).

Despite global finance ministers promising in 2010 that they wouldn't engage in “competitive devaluation,” it looks like the world is on the brink of a major currency war, or so says Alexei Ulyukayev, first deputy chairman of Russia’s central bank, according to Bloomberg.

“Japan is weakening the yen and other countries may follow,” Ulyukayev warned today at a conference in Moscow, adding later that the world is headed for a “currency war.”

Unfortunately, Ulyukayev isn't the only one with currency concerns. Others have weighed in on the issue :

• Luxembourg Prime Minister Jean-Claude Juncker recently noted the “dangerously high” value of the euro.
• Norway and Sweden have expressed concern over currencies exchange-rates.
• The Bank of Korea has threatened "an active response" to current rates.
• Federal Reserve Bank of St. Louis President James Bullard said he’s “a little disturbed” by Japan’s actions and the risk of so-called “beggar-thy-neighbor” policies.
• Bank of England Governor Mervyn King said last week that he is worried “we’ll see the growth of actively managed exchange rates.”

In short, there’s a “degree of disquiet in the global policy-making community,” as Reserve Bank of Australia Governor Glenn Stevens puts it, and some think it could evolve into something far more dangerous for the world economy.

This “will go down as the first day European policy makers fired a shot in the 2013 currency war,” Chris Turner, head of foreign-exchange strategy at ING Groep NV in London, told Bloomberg.

But let’s back up for a moment and try to wrap our heads around what’s going on here. Why would G-20 leaders inch toward “competitive devaluation”?

“Currency devaluation makes a country's goods and services more affordable to the rest of the world," Elliott Orsillo, CFA, co-founder, and portfolio manager at Season Investments, LLC tells TheBlaze.

"Therefore, if one country can weaken their currency versus other trading partners, it can give itself an economic boost from the increased demand for their cheap goods and services," he adds.

Of course, there's a downside to this: If one country can benefit from competitive devaluation, you better believe others will want in on the action. Hence, currency wars.

"When one country tries to get the upper hand by weakening its currency (like the U.S. has done with all the QE [quantitative easing] programs and Japan is starting to do with their inflation target), it forces the hand of other countries that want to remain competitive in the global economy," Orsillo explains.

"Currency wars create a ‘race to the bottom’ as each country tries to weaken their currency by more than everyone else,” he adds.

As of this writing, Japan is considered by many to be the "worst offender" as it actively intervenes to depress the yen.

“If Japan continues to pursue a softer currency, reciprocal devaluations would hurt the global economy,” Bloomberg reports, citing Russia’s Ulyukayev. “That echoes recent concern from other international policy chiefs.”

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Featured image courtesy Kiyoshi Ota/Bloomberg. Updated.