Are we about to be sucked into a currency war? As the world economy continues to splutter, countries are looking for ways to break out of the mire. One way of gaining popularity is to promote growth through making exports cheap. The key to an export-led recovery is to devalue a national currency, thereby lowering the prices of exports. By allowing its currency price to slide, a nation can launch a surreptitious trade war against its commercial rivals. Western nations have for years accused China of taking an unfair trade advantage by keeping its currency, and therefore export prices, artificially low. By allowing their currencies to devalue, Western countries are fighting back.

There are indications that the early skirmishes of a currency war have begun. This is a dangerous business. If countries undercut their competitors’ prices by devaluing their currencies, the stability of the world economy is put at risk. A full-fledged currency war invites deflation, a ruinous downward spiral of prices that in turn invites a worldwide recession. The cause of the conflict lies in the failure of the chosen measure to offset a Great Recession since 2008: wave after wave of “quantitative easing” (QE) by central banks to beat stagnant growth. QE was intended to funnel cheap money into national economies to boost economic activity and increase aggregate demand, thereby creating growth and jobs. But persistent QE has had an important unintended consequence. It has removed a key measure by which traders judge sovereign interest, or the ability of a country to pay its way.

Before the financial freeze of 2008-9, traders who worried about a country’s solvency would decline to buy government bonds or insist on a punishingly high return. That mechanism became confused when, to head off a precipitous Great Recession, finance ministers from the leading industrial nations agreed to pump vast amounts of newly minted money into their economies until the danger had passed. QE, or the buying of government bonds by central banks, was intended to reduce general borrowing costs and allow businesses to borrow cheaply to invest, and thereby employ the jobless.

That did not happen. Banks — fearful of making imprudent decisions similar to the ones they made on mortgage lending that plunged the world economy into a slump in the first place — have been hoarding money, have bought other banks with it, or have awarded it as bonuses to their executives. Businesses, fearful of making large investment decisions so long as demand remains sluggish, have also sat on their cash reserves. The result is the low- to no-growth economy we are currently enduring. John Maynard Keynes thought this would happen. As he told Franklin Roosevelt, it is “like trying to get fat by buying a larger belt.” Providing endless supplies of cheap money cannot in itself lead to growth. Measures to promote demand can best do that.

Meanwhile, traders have been deprived of the way they traditionally reflect their assessment of a nation’s economic worth. When central banks furiously buy government bonds to keep interest rates low, the bond price mechanism becomes redundant. But traders can continue to express their sovereign concerns via the currency market. It appears some functions of the distorted bond market have been replaced by the currency market. As Paul Kavanagh of Killik Capital told the BBC, “The bond market is, for want of a better word, being manipulated by this QE buying at the moment, making it very hard for it accurately to express sovereign interest, where currencies maybe are.” Currency prices have always been a good reflection of a country’s worth and have become even more so since QE.