Currency wars and "beggar thy neighbor"

Currency wars have been and will continue to be the focus of FX markets especially with the strong currency moves we have seen year to date. However, there is a distinction between using currency as a policy for domestic improvement and movements in exchange rates which are related to monetary policy changes. some can view the end result as the same but there is a strong distinction and it is non-market related actions which are truly an issue of currency wars. Monetary policy changes will drive exchange rates but that is not the same as systematic policies to exploit export versus import prices. Charts were taken from editorial by Gavyn Davies "Who is afraid of currency wars?" ft Feb 3rd 2013

The beggar thy neightbour form of currency wars tries to improve the competitive trade position of a country versus other trading partners. This would be the policies pursued in the 1930's as an effort to change the terms of trade and then the response in a form of Tit-for-tat strategy by other countries to regain or improve their  competitive position. 

The currency wars of the 1930's was a result of sterling going off the gold standard and the resulting response of other countries to control any sterling advantage through trade restrictions.  Those countries which moved off the gold standard first were to some degree able to better weather the depression than those that used trade restrictions. Moving off the gold standard allowed monetary policy to be used  domestically without regard for currency changes. This has given some the idea that monetary policy changes that lower the nominal exchange rate will be an effective growth strategy. 

In reality the beggar thy neighbour period led to world production actually growing but trade falling. The gap between production and trade resulted in less gains from trade and a world that was economically worse off. The first figure shows the decline in world trade while the second shows the gap between production and trade. 

What is really a currency war to be worried about will be the use of capital controls or other types of regulation to change the flow of goods and money. This is financial repression on an international scope and scale. Linking to financial repression is important because capital flows are more important and larger than trade flows and it is the capital flows through trade finance that facilitate the trade flows. A currency war would exist when a country tries to improve its competitive position while also not changing domestic inflation rates. 

Monetary policy which increases domestic inflation and thus effect nominal exhcnage rates cannot really be thought of as a currency war shot or tool. The decline in the nominal exchange rate is just a result of inflation differences. Bluster may be associated with monetary policy differences but it is not the same as a trade war.