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Currency War: What you need to know

Adam Shell, USA TODAY5:06 p.m. EDT August 12, 2015

Chinas surprise move Monday to reduce the value of its currency versus the dollar has Wall Street
fearing a currency war. Adam Shell with Americas Markets.

Most investors have heard of the Cold War and theWar on Terror. But Wall Street is
now worried about another type of war, one fought on the financial battlefield and one
most investors know little about: a so-called "Currency War."

Blame China for talk of a currency war on Wall Street. On Tuesday, China surprised
markets by devaluing its currency, the yuan, by nearly 2% vs. the dollar -- the biggest
one-day fall in two decades. The move is intended to bolster China's lagging exports
and weakening economy by making Chinese-made goods cheaper to purchase abroad.
The yuan was devalued further Wednesday, adding up to its steepest two-day decline
since 1997, according to Gluskin Sheff.

In an attempt to get investors battle-tested, here's a quick primer on why a currency war
impacts savings and investments.

What is a currency war? It's when countries use their currency as a competitive
weapon. Simply put, it is when a country "engages in policies" meant to reduce the
value of their currency in an effort to boost competitiveness by "stimulating exports and
economic growth," says Alan Skrainka, chief investment officer at Cornerstone Wealth
Management.

"This happens because your products are now cheaper on world markets," says
Skrainka.

Why did China devalue its currency? Because its economy, the world's second-
largest and a key engine of global growth in recent years, which has a targeted growth
rate of 7%, is in slowdown mode, putting the 7% growth rate at risk. In a sign of trouble,
Chinese exports plunged more than 8% in July vs. the same period a year ago.
Authorities in Beijing, which Wall Street says is also dealing with real estate and stock
market bubbles, are desperate to stabilize its economy.

"it's clear," says Quincy Krosby, a market strategist at Prudential Financial, 'that China is
now on a path to weaken the yuan to spur growth."
Is the push to devalue currencies new? Not really. For the most part, the term
"currency war" is often overused and dramatized. The U.S. dollar, for example, took a
steep dive after the 2008 financial crisis after the Federal Reserve cut interest rates to
zero percent and flooded the world with cheap money with its government bond-buying
program, dubbed QE. In early 2013, Japan took similar steps to boost growth by
devaluing its currency, the yen, as did the European Central Bank with the euro at the
start of 2015.

Why is Wall Street worried? A number of reasons. One, China's move suggests that
its economy is in worst shape than believed. "It highlights the fragility of the global
economy," says Donald Luskin, chief investment officer at TrendMacro. Second, a
weaker yuan means a stronger dollar, and a stronger dollar means U.S. products sold in
China are more expensive, which means fewer sales of Apple iPhones, hotel rooms
offered by Wynn Resorts and computer chips made by Micron Technology.

Lastly, there is a fear that other nations will respond to China by devaluing their own
currencies to stay competitive.

"When people start talking about 'currency wars,' it's never a good thing," says Michael
Farr, president of money-management firm Farr, Miller & Washington. "China's move to
devalue its currency could be the first shot across the bow towards a wider currency
war."

Why are currency wars feared? "A currency war is really a race to the bottom,
whereby one country after another devalues their currency to gain an export price
advantage, creating too much supply and not enough demand, which elevates the risks
of even more anti-growth protectionist measures," says Joe Quinlan, an investment
strategist at U.S. Trust. "Currency wars are anti-growth and deflationary."

That hasn't happened yet.

Did China's move start a currency war? "No, says Prudential's Krosby. "It's not the
beginning of a full-fledged currency war. It is a pragmatic move to help a weakening
economy."

"This issue is being blown way out of proportion," adds Nick Sargen, chief economist at
Fort Washington Investment Advisors. "The market has incorrectly assumed China is
now taking action to depreciate its currency, when in fact it is allowing market forces to
determine the value."