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Tuesday, April 12, 2011

What is currency manipulation?

Currency prices are influenced by central bank monetary policies
Devalued currencies make exported goods cheaper for importers
Currency manipulation is the influencing of currency valuations in proportion to the value of other currencies, and in terms of trading price bid ask spreads which is the difference between selling and asking price of a currency pair. Currencies change in value daily based on market conditions and foreign exchange transactions. However, these changes can be manipulated directly or indirectly through governmental decision-making, monetary policy and institutional market based strategy.

Both the United States and China have been accused of manipulating their currency in recent times. More specifically, China limits how much its currency, the Yuan-Renminbi, appreciates in value only allows it i.e. the Yuan-Renminbi to fluctuate a certain amount in value thereby influencing both national currency, Gross Domestic Product and trade balance.
In the case of the United States, monetary policy that significantly affects currency value has been considered a direct effort to debase the dollar. However, U.S. officials such as Treasury Secretary, Timothy Geithner have denied this claim stating that a devalued currency is not the intention of liquidity, but rather a bi-product of economic stimulus.

The above examples are indicative of trends within currency wars. This occurs when multiple nation-states are believed to be in competition against each other via the price of their currency. A potential consequence of global currency manipulation that motivates the currency war in the first place is economic strength linked to high exports. 

Since exports often increase when the prices of goods and services are cheaper, the advantages of a lower valued currency can be profound. Thus, currency manipulation may be more likely during periods of global economic struggle rather than prosperity. Countries may compete for lower currency prices by either directly pegging their currency to another via political means, or by altering the money supply through monetary policy.

Financial institutions may also manipulate currency by trading both ends of currency transactions and betting ahead of the market. For example, ABC Financial Intermediary is a financial institution that facilitates foreign exchange for individual clients. Via this information, and with direct access to large amounts of financial leverage, company's can essentially see what is going to happen in a market before it actually happens and make currency trades that allow them to be profitable, and limit the movement of currency prices to their advantages. This is more likely to be the case with unregulated foreign exchange brokers which is a potential pre-cursor to currency manipulation.

Enforcement of currency manipulation is sometimes weak according to the Congressional Research Service. This is because large international financial institutions do not always have the power to require countries to alter their national monetary policy. Similarly, the Congressional Research Service also state the World Bank, another large global financial intermediary does not have a large scope of authority in terms of subsidizing specific goods that in effect has a similar function as devalued currency. Since nation-states are sovereign entities, collaboration and agreement regarding monetary policy may be one of the few effective ways to avoid national currency manipulation.

Sources: 

1. http://bit.ly/c2iLL5 (Congressional Research Service)
2. http://bit.ly/bP5dIO (Yahoo Finance)
3. http://bit.ly/9qQRyn (National Futures Association)

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