[Currency War Part 2] Definition of Currency War and Lessons from the Great Depression | The Race to the Bottom in Economy and Currency

[Currency War] Definition of Currency War and Lessons from the Great Depression

In Part 1, we looked at how America's high tariffs could become the trigger for a currency war. In this Part 2, we will delve deeper into the concept of a currency war and analyze why it is a self-destructive phenomenon that harms all participating countries. Through the historical case study of the Great Depression in the 1930s, the most famous example of a currency war, we aim to clearly understand the true nature of the risk we are currently facing.

Definition of Currency War and Lessons from the Great Depression (Part 2)

1. What is a Currency War?

A currency war refers to a situation where countries in international relations intentionally lower the exchange rate of their own currency to gain a trade advantage over other nations. This is also called 'competitive devaluation'. The goal is to make the country's exports more price-competitive in the overseas market and imports more expensive domestically, which aims to have a positive impact on domestic industry and employment.

1.1 'Beggar-thy-Neighbor' and the 'Race to the Bottom'

The core mechanism of a currency war is explained by the 'beggar-thy-neighbor' policy. This means that one country's economic gain is achieved at the expense of its trading partners. However, if multiple countries simultaneously pursue this strategy, the initial competitive advantage is quickly offset by retaliatory devaluations from other nations. This situation creates a destructive cycle called the 'race to the bottom', where the gains are short-lived or non-existent. Ultimately, it collectively harms all participating countries by shrinking the total volume of international trade and destabilizing the global economy.

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2. Lessons from the Great Depression of the 1930s

The Great Depression of the 1930s is recorded as the 'textbook example' of a widespread currency war. During this period, more than 70 countries abandoned the gold standard and devalued their currencies between 1929 and 1936 to boost their economies and 'export unemployment.' However, these devaluations led to immediate retaliatory devaluations and tariff impositions from trading partners, preventing any country from gaining a lasting advantage. Empirical studies show that countries that devalued their currencies experienced a trade volume decrease of more than 21% compared to their non-devaluing partners.

This suggests that currency wars severely harmed global trade and increased friction. This period is evaluated as one that negatively impacted all participating countries due to unpredictable currency fluctuations. The case of the 1930s provides an important lesson that competitive currency devaluation ultimately leads to a self-destructive outcome. While an individual country may initiate a devaluation with a specific economic goal, the inevitable retaliatory measures ultimately lead to a collective deterioration that harms all involved.

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3. Conclusion: Competitive Devaluation Leads to Self-Destructive Outcomes

The history of the 1930s clearly shows that while competitive devaluation may offer temporary gains, it ultimately leads to results that are detrimental to everyone. The intentional lowering of currency value to secure short-term competitiveness is the beginning of a self-destructive vicious cycle that leads to a decline in trade volume and instability in the global economic system. The currency volatility caused by the current US protectionism reminds us once again of these historical lessons. In the next Part 3, we will analyze the specific impacts of this global trend on our South Korean economy and discuss wise response measures.

Key Summary:
A currency war is an act of intentionally lowering the value of one's currency to gain export competitiveness. However, this triggers retaliation from other countries, leading to a 'race to the bottom' where all nations lose, a danger proved by the Great Depression of the 1930s.

The contents of this blog are for reference for investment decisions only, and investment decisions should be made under one's own judgment and responsibility. Under no circumstances can the information in this blog be used as legal evidence for the outcome of an investment.

▶View References◀

1. Currency war - Wikipedia
2. Currency Manipulation and Currency Wars Explained | IG International
3. Currency War: Definition, How It Works, Effects, and Example - Investopedia
4. Currency Wars and Monetary Regime Disintegration - PEIF Conference
5. peif.conferences.wcfia.harvard.edu
6. DP19839 Currency Wars and Trade - CEPR
7. www.investopedia.com
8. The Long-lasting Economic Shock of War - International Monetary Fund (IMF)

▶Currency War Part 1

▶Currency War Part 2

▶Currency War Part 3