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When G20 finance ministers and central bankers gather Friday for two days of talks in the touristy South Korean coastal city of Gyeongju, it will be against a backdrop of growing global tensions. Like most of us facing tough economic times, what countries do with their money is at the heart of the trouble.

Some are keeping exchange rates artificially low, either by selling huge amounts of their currency or printing more. Others are awash in other people's money, which threatens to hike prices of financial assets, triggering inflation and wreaking havoc on their economies. What they have been doing - or threatening to do - to protect themselves runs the gamut from provocative - but legal - to downright dirty.

So far, most of the shots fired in the Great Currency War of 2010 have been verbal, especially between the two main combatants, the United States and China. But Japan, Brazil and a dozen smaller countries caught in the crossfire have been dusting off their weapons. And as they plot or deploy such defensive tactics as direct intervention in the foreign exchange market, deliberate devaluation and curbs on capital inflows, the risks rise that the shouting will turn into shooting, with potentially devastating consequences.

Mervyn King, Governor of the Bank of England, warned this week of the danger that some countries could turn to protectionist retaliation if the tension escalates: "That could, as it did in the 1930s, lead to a disastrous collapse in [economic]activity around the world."

The finance ministers will undoubtedly leave South Korea with a public commitment to avoid shafting each other to protect their own national interests. Their pledge will be worth about as much as a politician's promise in an election campaign if the leading currency culprits continue to behave badly. The we're-all-in-this-together spirit that helped revive global fortunes after the near collapse of the financial system in 2008 is long gone.

The friction has been building for months, but it took Brazil's outspoken Finance Minister, Guido Mantega, to declare last month that actual hostilities have broken out.

The problem, explained Mr. Mantega, is that some countries have chosen to deliberately cheapen their currencies to make exports more competitive. Their intention, he declared, is to revive their economic fortunes at the expense of faster-growing emerging countries like his own. There is little doubt he was pointing at Washington, poised to launch another round of what central bankers call quantitative easing and the rest of us call flooding the market with money.

A bigger worry is that investors fleeing a cheapened U.S. dollar, Japanese yen or Swiss franc will pour money into booming Brazil and other expanding economies in amounts that will trigger dangerous inflation.

Some analysts insist that comparisons to the disastrous trade policies that paved the way for the Great Depression are far fetched. Others warn that hard economic times typically cause governments to circle the wagons. Protectionist policies are politically popular in times of high unemployment. And they may even work … until everyone else piles on.

"This isn't a currency war as much as a currency bar brawl," says Randy Cass, founder of Toronto-based analytical firm First Coverage. "These countries aren't thinking strategically about the long term and this isn't in the least about emerging victorious. Almost every country involved right now is just hoping to be less bloodied than the others when last call is shouted."

The leading players in this drama, China and the U.S., have long been on a collision course

. Washington berates Beijing for refusing to allow the market to determine the value of its yuan, and Beijing counters that the U.S. and other industrial countries are the authors of their own misfortunes.

Now, the U.S. is playing the Chinese game, devaluing to win back market share and stitch up its tattered economy. But because the Chinese have tied the yuan to the greenback, a cheaper dollar won't hurt Chinese exports.

"The big fact is not that some countries are manipulating their currencies, because this is not new," says Nicolas Véron, a senior fellow at Bruegel, a Brussels think tank. "The big fact is that one country which is manipulating its currency and has for a long time has become one of the pillars of the global economy. I don't think anybody accuses China of having worse behaviour than before. It's just that China has become so important that the requirement that it should play by the rules is gaining prominence."

But for Washington, it's a case of the pot calling the kettle black, says economist Ken Courtis, founding partner of Themes Investment Management in Hong Kong. He argues that despite Washington's official insistence that it has no intention of devaluing the dollar, that is exactly what's happening, the goal to revive its economy at the expense of its trading partners.

"Certainly, it is, by any other name, a beggar-thy-neighbour policy, which history has demonstrated, time and time again, leads to nothing but more trouble."

What really worries China about a currency war is the impact this would have on its trillions of dollars worth of investments tied up in U.S. Treasuries and other securities. A 20-per-cent devaluation of the greenback against the yuan "would mean that the value of China's investments in the U.S. would instantly shrink by half a trillion dollars," Mr. Courtis points out.

So the stakes are high; too high, it would seem, for myopic governments to pursue disastrous tit-for-tat retaliation that would make losers of us all.

There was a hint of a possible détente Thursday when U.S. Treasury Secretary Timothy Geithner assured Mr. Mantega that the U.S. still favours a strong dollar.

But then, plenty of voices were saying that sort of thing in 1930.

Fighting words

1. Taxing the hot money. Rapidly growing emerging countries are facing a flood of speculative cash that is driving up their currencies and threatening to inflate dangerous asset bubbles. Market players borrow money at almost no cost in the U.S., Japan and Western Europe and pour it into higher-interest debt and other assets in the boom zones. China keeps a tight lid on capital flowing in and out. And now more open developing economies such as Brazil, Thailand and South Korea are imposing new taxes on foreign purchases of their short-term bonds.

2. Direct intervention in the foreign exchange market through the sale of vast amounts of your own currency. Usually a losing proposition. The Japanese have gone this route to help battered exporters and make the yen less enticing to foreign investors seeking safe harbours in a world fraught with increasing danger. Brazil, South Korea and Taiwan have also intervened in the foreign exchange market to keep hot currencies in check.

3. Currency manipulation. Simply set an artificially low exchange rate, score huge gains in exports and tell your trading partners you need a break because you're just a poor developing country. No one does this better than China, but a bunch of developed countries, including the U.S., don't exactly have clean hands. The risk is eventual trade retaliation. The main counterweapons so far, though, have been empty volleys of rhetoric and some behind-the-scenes arm twisting.

4. Beggar thy neighbour. In the wake of the global recession that followed the near collapse of the financial system, everyone has decided the best chance at a sustained recovery is through more exports. And since Mars isn't shopping, that means doing whatever it takes to grab market share from your Earth-bound neighbours.

5. Sanctions. If the situation goes from bad to worse, governments will always opt to protect their own interests first, which will mean unsheathing such weapons of massive trade and investment destruction as curbs on capital flows, punitive tariffs and a raft of regulatory roadblocks. No one really wants a return to the Dirty Thirties, but once the shooting starts, it may be hard to stop.

Preparing for the financial apocalypse

If full-scale war does break out, no one knows quite what to expect. But here are some tips, just in case the world as we know it blows up and the Four Horsemen climb back on their mounts.

1. Don't keep all your nest eggs in one currency. The professionals recommend socking some cash in foreign funds. Curbs on money flowing in and out would be an ever-present risk. But cash will still pour into Brazil, India, Indonesia and other former have-nots of what used to be known as the underdeveloped world, while the old haves, including the U.S., Japan and parts of Europe, become less attractive. Which happens when you're weighed down with soaring deficits, aging populations, creeping political paralysis and dimming prospects.

2. Build a bunker, preferably reinforced, to store your gold bullion. The stuff takes up a lot of space and it's heavy. The bunker could come in handy for other uses, too.

3. Dump those long-term bonds. You don't want to be a lender at times like these. The U.S. is trying to reflate its way out of trouble, with the help of a depreciating greenback. But the consequence could be double-digit inflation, which is death to fixed-income investments. A mere 3-per-cent rise in interest rates, which would take Canadian and U.S. rates back to historic levels, would wipe out about 45 per cent of the principal.

4. To be on the safe side, go further than even Bank of Canada Governor Mark Carney suggests and stop borrowing, even if you can afford the rates for now.

5. Buy land in some remote spot and get one of those long guns, registered or not. After the financial meltdown of 2008, a Wall Street strategist actually suggested buying a farm in northern Saskatchewan that could be reached by road and provide enough food to make a family self-sufficient.



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