Currency war: yuan and dollars In the wake of a severe worldwide recession, spiking prospects of currency wars are now threatening the fragile global economy. In response, high-profile policymakers are rushing to try to restore calm.

Officials at the International Monetary Fund and World Bank became the latest to attempt an easing of the escalating tensions. Their comments echo remarks by European Central Bank head Jean Claude Trichet against disorderly moves in currency markets. U.S. Treasury Secretary Timothy Geithner has also called for greater cooperation as relations between the U.S. and China become more tense.

Investors would be wise to take this type of lip service with a grain of salt. Despite the calls for order, policymakers are dealing with an increasingly haphazard scenario loaded with counterproductive results and unintended consequences. And that could mean a slide toward protectionism even though it would hurt all parties involved.

Still Trying to Weaken the Yen

While officials may posture, the levers that they have to influence the finicky and massive global currency markets remain limited. These markets also tend to be highly responsive to what other countries are doing, thereby curbing and confounding the influence of each individual party.

Japan, for example, has been trying to weaken the yen for months. But even the recent direct intervention often credited with setting off the current bout of competitive devaluations has had very limited success. Investors are still hanging on to yen as a safe haven currency in anticipation of deflationary conditions that boost purchasing power over time and massive current-account surpluses.

The reverberations are being felt in Europe as well. It was fashionable to talk about the end of the euro at the start of the year. But now the currency is surging as the European Central Bank takes a less aggressive monetary policy stance than its rivals.

Yet, the tensions within Europe are likely to be profound as well. High savings rates in Germany mean printing money is hardly desirable for the euro's politically powerful cornerstone. On the other hand, a surging currency could quash a broader export-led recovery that's keeping battered Southern European economies like Greece afloat.

Carrot-and-Stick Diplomacy

Meantime, the U.S. dollar has slid against a basket of currency as the Federal Reserve makes increasingly clear its intentions to drive down interest rates by purchasing bonds. And as congressional elections approach amid the weak American economy, investors have understandably focused on the high-profile row materializing between the U.S. and China.

China is engaged in classic carrot-and-stick diplomacy. Chinese Premier Wen Jiabao recently assured Europe that his country would be helpful in everything from propping up the yuan to buying Greek bonds.

But the fast-growing giant also has its hands tied. Letting the yuan appreciate too fast would hammer the razor-thin margins of Chinese exporters, Wen warned. That could lead to a wave of bankruptcies in the sector and create enormous social upheaval as workers migrating from rural China are unable to be absorbed into the urban population.

Exactly the opposite, though, has occurred, thanks to the dollar's slide. With the yuan effectively pegged to the greenback, any advantage China has because of its cheaper currency compared to regions like Europe has only been enhanced.

As tensions mount, the growing roster of dignitaries urging calm should rise as well. Ultimately, though, investors should recognize that only highly scattershot policies are likely to unfold.

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Robert & Lisa, The average unemployment rate during the Bush Administration was 4.7% today thanks to Obama and liberal demo views toward Captialism the unemloyment rate has doubled.....The dollar has become much weaker driving oil prices up.... Socailism doesn't work except making eveyone poor!

October 08 2010 at 1:10 PM Report abuse +2 rate up rate down Reply

Robert & Lisa: While I can concur that the Obama administration is something to be desired, the Bush administration was nothing to be proud about either.

October 08 2010 at 6:04 AM Report abuse -3 rate up rate down Reply

A slide towards protectionism? Well, it's certainly well over due. We need to slap steep duties on all imported goods and services as well.

October 08 2010 at 6:00 AM Report abuse +2 rate up rate down Reply
Robert & Lisa

Unemployment has just exceeded 10% for the second time under Obama and thugs. Hope you Obama lovers are happy now. Thankfully, the states that supported him the most have the most unemployment.

October 08 2010 at 3:21 AM Report abuse +5 rate up rate down Reply
Robert & Lisa

Can you believe the Demoncrat leaders actually saying more people on food stamps helps our economy. Vote the idiots out.

October 08 2010 at 3:20 AM Report abuse +4 rate up rate down Reply
Robert & Lisa

All of you young people that don't really keep up with politics. Please don't vote because you just screw things up for everybody including yourselves.

October 08 2010 at 1:56 AM Report abuse +3 rate up rate down Reply
Robert & Lisa

It is amazing how stupid our children have become from our socialized educational system in the past 50 years since I was a kid.

October 08 2010 at 1:54 AM Report abuse +3 rate up rate down Reply
Robert & Lisa

Our currency and country is going to continue to decline as long as we have policies which reward people who go from being productive to on the government dole. The fewer products and services we produce as a nation, the lower our standard of living will be.

October 08 2010 at 1:44 AM Report abuse +2 rate up rate down Reply

This country could be a little more "protectionist" after losing all our industry due to so-called "free trade". To hell with people who want to buy cheap trinkets at the cost of millions of Americans without jobs.

October 08 2010 at 12:53 AM Report abuse rate up rate down Reply

Want to send a message to the US Congress and US Senate, if you are pissed about them giving TARP BANKS Billions when you told Capitol Hill NOT to. Then send a loud and clear message pull all money out of TARP BANKS and do NOT deal with them or stores that have TARP BANKS supply them with credit cards. With out customer support the TARP banks will fold and your message will be heard loud and clear in Washington DC. Play your ace or shut up and bend over for congress ,the senate the TARP banks, and all other big business that our lovely DC government caters to with your tax money hand outs.

October 08 2010 at 12:38 AM Report abuse +2 rate up rate down Reply