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How Trade wars and Forex cause MAD

By Louis Holding-Parsons on May 15, 2019

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Any war is usually bad as destruction follows. Trade wars and Forex are an economic sort of war where one country seeks to make itself competitive, by making a rival’s products less attractive. Usually the first sign of such a war is a devaluation of a currency against others.

Trade wars and Forex do not necessarily involving shooting each other!

During the Cold War, a term was invited called: “Mutually assured destruction” (MAD). This implied that in pursuing certain policies, both counterparts were likely to ensure their destruction. Trade wars and Forex are not exempt from this, nor is Forex trading. The free movement of goods is a basic economic theory. The less you work together the more you damage each other’s interests. In effect you are working against each other creating a situation where you both end up poorer! Trade wars and Forex can start for a variety of reasons, in this case the USA feels aggrieved by Chinese economic policies. The USA has accused China (among other things) of stealing intellectual property and the devaluing of its currency, to make its exports more competitive. This affects US manufacturers as they are competing against Chinese competitors. The latter are able to offer lower prices because their currency is artificially lower than the US dollar. This also affects market trends.

Trade wars and Forex effect

The USA and china are at loggerheads over Trade wars and Forex

The Chinese Renminbi (CNY) has historically been considered by some western commentators to be trading below its value. The suggestion being that Beijing has deliberately done this to keep domestic economic growth around the 6-7% which is considered their yearly target. As a result the Renminbi is considered a Fixed exchange rate currency as opposed to the floating exchange rate currencies in the West. This is because it is kept ‘under control’ by the the people’s bank of china, so as to not hurt Chinese exporters. Such central bank monetary policies are not abnormal for countries where politics and economics are essentially as one with little independence of one from the other.

Brexit’s contribution…!

Trade wars and Forex involve Brexit Political discord can also lead to trade wars and Forex. The ongoing Brexit divorce process is about agreeing to terms on which to trade. Various trade terms are being discussed. At the time of writing the inability of the current political party in power to agree on what trade terms are acceptable are leading to a war within a war! Post-Brexit markets will be different due to this divorce. This will have an effect on the value of Pound Sterling and will lead to some new trading ranges being established and discovered.

Conclusion

A trade war usually ends up with both countries involved losing out. This is another reason why currency trading is not for the faint hearted. Sometimes one currency will actually strengthen when a trade war occurs, as the market agrees with that countries stance. Trade wars are a form of geopolitical event. In the West we are used to governments following broadly open economic policies which make sense to any financially literate follower. Yet as a retail Forex trader you should always realise that what is the norm may not be reflected in the market. Keeping an open mind is important for any aspiring Forex trader which allow you to sidestep the landlines and become a profitable trader!

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Louis Holding-Parsons

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.