The specter of a global currency war is looming large following Switzerland’s surprise decision to peg the Swiss franc to the euro in a bid to hold back a runaway appreciation of its safe-haven currency.
The Swiss National Bank shocked global markets Tuesday by declaring that it would cap the franc’s rate at 1.20 francs to the euro by buying other currencies in “unlimited quantities.” The currency gained more than 20 percent against the euro and the U.S. dollar this year and reached a record high last month. It nearly touched parity with the common currency as investors increasingly sought shelter in it amid the eurozone’s worsening sovereign debt crisis.
The SNB’s move was a desperate effort to prevent an overvalued currency from damaging the nation’s export-driven economy. The franc’s sharp gains posed “existential” problems for Switzerland by dampening its exports, hurting tourism, and threatening to push the economy into a recession.
But the bank’s unexpected action could push the world into a new currency battle. According to news reports, the SNB’s shift to a fixed rate regime could divert pressure to currencies of non-eurozone countries, such as Norway, Denmark, Sweden and the United Kingdom, forcing them to intervene to stem unwanted appreciation.
The bank’s initiative is also expected to increase demand for other safe-haven currencies, such as the Japanese yen and the Australian dollar. If these currencies gain value, it will push up other Asian currencies, including the Korean won, as currencies in the region move in tandem.
Japan, which has been struggling to curb the yen’s appreciation, is unlikely to follow the Swiss bank’s move, but it may have to intervene on a larger scale if pressure piles on the yen.
As such, currency intervention is likely to increase in frequency as well as scale. Countries around the world face a greater need to stabilize their currencies as they seek to export their way out of slow growth in the face of the deteriorating prospects for the global economy.
Our concern is that increased intervention could escalate into a currency war if not coordinated by central bankers and political leaders. Last year, when fears of a currency war heightened following the second round of quantitative easing by the U.S. Federal Reserve, the Group of 20 countries sought cooperation to avert a full-fledged war. Now, such efforts appear to be more difficult to foresee.
In this context, Seoul officials need to step up their monitoring of financial markets and be ready to take steps to prevent excessive market volatility and check unwarranted appreciation of the Korean won.
In particular, they need to watch closely how the eurozone financial turmoil unfolds as many European banks exposed to sovereign debts of Greece, Italy and other troubled countries are experiencing a credit crunch.
Some of Europe’s weaker banks now rely on European Central Bank funding as they have been locked out of money markets. Healthy banks refuse them short-term unsecured loans because of concerns over their ability to repay.
These banks are expected to unwind their investment abroad as their liquidity problems are worsening. Then Korea could suffer a sudden outflow of foreign capital.
