Currency manipulation

Definition

Currency manipulation refers to the practice where a country's government or central bank artificially influences the value of its currency to gain an unfair advantage in international trade. By deliberately keeping their currency undervalued, these countries can make their exports cheaper and imports more expensive, which can lead to a trade surplus and negatively impact other nations' economies.

5 Must Know Facts For Your Next Test

1. Currency manipulation is often condemned by international organizations like the International Monetary Fund (IMF) and can lead to trade disputes and tariffs.
2. Countries may use various tools to manipulate their currency, including direct intervention in the foreign exchange market or adjusting interest rates.
3. The practice can create tensions between trading partners, as countries that feel disadvantaged may retaliate with their own currency policies or protectionist measures.
4. Economic models suggest that while currency manipulation can provide short-term benefits, it may lead to long-term instability and retaliation from other nations.
5. Historically, countries like China have faced allegations of currency manipulation, affecting their trade relationships with major economies like the United States.

Review Questions

• How does currency manipulation affect a country's trade balance?
  • Currency manipulation can significantly influence a country's trade balance by making its exports cheaper and imports more expensive. This often results in a trade surplus, as foreign buyers are more inclined to purchase the manipulated country's goods. Conversely, importing becomes costlier for consumers and businesses in that country, which may lead to reduced demand for foreign products. Ultimately, this practice distorts fair competition in international markets.
• What are some economic consequences of currency manipulation on global trade relations?
  • Currency manipulation can create significant economic consequences for global trade relations, including increased tensions and potential trade wars between countries. Countries that perceive themselves as victims of manipulation may impose tariffs or other trade barriers in retaliation. Additionally, such practices can lead to misallocations of resources globally, as artificially low currency values disrupt normal market signals and influence decisions on investment and production.
• Evaluate the long-term implications of currency manipulation on both the manipulating country and its trading partners.
  • In the long term, currency manipulation can have detrimental effects on both the manipulating country and its trading partners. For the manipulating country, reliance on an undervalued currency might initially boost exports but can lead to economic imbalances and inflation. For trading partners, they may experience slower economic growth due to reduced demand for their goods and potential job losses in export sectors. Moreover, retaliatory measures could escalate tensions, leading to broader economic instability and potentially affecting global markets.

Related terms

foreign exchange market: A global decentralized market where currencies are traded, and exchange rates are determined based on supply and demand.

devaluation: A reduction in the value of a currency relative to other currencies, often implemented by a government to boost exports.

trade balance: The difference between a country's exports and imports; a positive trade balance (surplus) occurs when exports exceed imports.