FP Explainer

Why Do Currency Wars Start?

Because when one country plays with its exchange rate, everyone else has to.

Responding to Japan's unilateral intervention to weaken the yen, followed by similar moves from Colombia, Thailand, South Korea, and other countries, Brazilian Finance Minister Guido Mantega recently declared that the world is "in the midst of an international currency war." In an effort to recover from the global economic crisis, these countries are attempting to stimulate their exports by making their currencies cheaper. These efforts add to the longstanding tensions between Western nations and China over the latter's monetary policy, which many say keeps the yuan artificially low. Could things be getting out of hand?

IMF Managing Director Dominique Strauss-Kahn, among others, has also warned against countries using currencies as "policy weapons." French Finance Minister Christine Lagarde has urged countries to talk about "peace and not war." But U.S. Treasury Secretary Timothy Geithner has denied that there's a currency war going on and says there's "no risk" of one breaking out.

So what exactly is a currency war and how do we know when we're in one, anyway?

We are when we say we are. A "currency war" is more of a political than an economic condition. Governments frequently intervene in their currency markets, increasing the money supply to stimulate trade and reduce unemployment, or decreasing the supply to combat inflation. The problem is that in an interlinked global economy, currencies don't rise or fall in a vacuum. When China keeps the yuan artificially low versus the U.S. dollar, it keeps the cost of Chinese goods low in the United States, contributing to a trade imbalance. That provides a steep incentive for the United States to retaliate by lowering its currency as well. Of course, becuase two countries can only have one exchange rate, this race to the bottom isn't likely to benefit either party.

When many countries devalue their currencies at the same time in an effort to make their exports more competitive, it forces other countries -- Brazil for instance -- to join in to prevent their currencies from rising. Countries often see currency wars as a zero-sum game -- one wins and the others lose. But the widespread devaluation can have a devastating effect on all. Unstable exchange rates can deter international investment, slowing the pace of global economic recovery. And of course, currency wars can have secondary political effects. When countries are fighting over currency, they're less likely to agree to bilateral trade. Additionally, currency pressures could make China less likely to go along with U.S. efforts to contain Iran or North Korea.

Unlike real wars, currency wars don't have defined start dates, but they can be ended with something like peace treaties. In 1936, Britain, France, the United States signed the Tripartite Agreement to address the currency imbalances that had resulted from Britain and the United States leaving the gold standard in the midst of the Great Depression. On the eve of World War II, with an even greater enemy on the horizon, the three countries agreed to refrain from devaluing their currencies.

In 1985, when Japan not China was the rising Asian economic power,  the governments of Britain, France, Japan, the United States, West Germany signed the Plaza Accord, under which the dollar would be allowed to depreciate against the yen.

Some are now calling for a new international agreement to stabilize the current round of depreciation. But, obviously, the world economy has changed quite a bit in the last 25 years. The growing power of emerging economies such as Brazil, China, India, and South Korea make it much harder for a few finance ministers in a hotel room to hammer out a deal. Moreover, previous efforts at stabilizing global exchange rates have caused the parties involved to lose faith when they're ultimately undermined by domestic policies.

So as with real wars, declaring one is often far easier than ending it.

Thanks to Barry Eichengreen, professor of economics and political science at the University of California, Berkeley.


FP Explainer

What Happens to a Place After It's Covered in Toxic Sludge?

Nothing good.

View photos of Hungary's toxic sludge disaster.

Hungarian authorities are currently struggling to contain the damage from a deluge of toxic sludge on Monday that resulted from a burst dam at an aluminum processing plant. At least four people were killed and over 100 injured by the 35 million cubic feet of sludge, which knocked cars off the road, burned through victims clothes and affected a 15 square mile area. Hundreds of people in several towns had to be evacuated by police. So just how long will it take for the region to recover from the sludge?

It depends on what's in it. Greenpeace workers who took samples of the sludge on Tuesday are having them tested to determine what exactly rescue workers will be dealing with. Experts believe the substance, a byproduct of refining bauxite into aluminum, is likely to contain heavy metals, such as lead, as well as high levels of arsenic. If these chemicals are present in high amounts, the area's soil could be contaminated for years to come. Children and pregnant women are most at risk, from high levels of lead, can cause birth defects and brain damage.

Once the sludge dries, the lead may be even more dangerous. If inhaled, the sludge dust can cause respiratory problems, even lung cancer.

Arsenic, which can lead to nerve damage, stomach pain, and some types of cancer, is extremely difficult to remove from soil and can be transferred into crops, threatening agricultural yields for years.

The most dangerous immediate factor is the sludge's high alkaline level. The aluminum plant's runoff has an extremely high ph level of around 13, meaning it can burn through the skin of those who come in contact with it. Most of the injuries reported so far have been alkali burns.

After the sludge itself is cleaned up, the affected soil will likely remain alkali, making it unsuitable for planting, and will have to be treated with acid before agriculture can resume (assuming it hasn't been poisoned by lead.)

Hungarian authorities say the sludge has not yet entered the region's water supply, but EU authorities worry that it could reach the Danube, one of Europe's main waterways, and be carried to countries downstream. This could be catastrophic. When a cyanide-contaminated storage pond burst into local rivers near Baia Mare, Romania, in 2000, it wiped out all fish and plant life in a several hundred kilometer swathe. Two years after the accident, fish populations still hadn't returned to their normal levels.

Authorities say the sludge itself will take a year to clean up. But it's clear that the region will be feeling the health and economic effects of the spill for years to come.