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Marketplace 's Paddy Hirsch is back at the Whiteboard . This time he's trying to get us to understand how currency wars affect us all. As usual, he removes the wonk from the discussion. This time using a story of sibling rivalry, honey, and the US-Canada border:

When the G20 meets later this week, avoiding a currency war will be one of the top issues for discussion . With Japan lowering the value of the yen, European nations are highly concerned that an artificially high euro (not just against the yen, but also against a relatively weak dollar) is exacerbating economic distress in the Euro Zone. In an interview with Knowledge@Wharton , Wharton School finance professor Franklin Allen explains how the actions of Japan's leaders might affect economies from Brazil to Russia:

Writing in the May/June issue of The American Interest , Barry Eichengreen argues that while the role of the dollar on the global economic stage is likely to diminish somewhat, it will be some time before we see any significant drop in the greenback's importance. But he uses recent currency maneuverings in China and Japan to outline some of the benefits we in the US receive from the dollar being the global currency. With international business being conducted in dollars, U.S. banks aren't burdened with a lot of the exchange rate machinations that banks elsewhere deal with. And the U.S. Treasury costs of borrowing are lessened by the stability that the dollar offers. And on the political front, Eichengreen points to " America’s unique ability to provide dollars in unlimited quantities, but also to withhold them, provides U.S. foreign policymakers with another pressure point to push." But Eichengreen points out that there are some downsides to the dollar being the global currency. By U.S. Treasury estimates, China holds some $1.1 trillion in U.S. government bonds. Total official foreign holdings exceed $3.2 trillion, nearly a third of the $10 trillion of U.S. Treasury debt held by the public. It is worth noting that these official figures are almost certainly underestimates. In addition to purchases in the United States, which are tracked by the U.S. Treasury, governments and central banks can purchase U.S. Treasury bonds through intermediaries in foreign centers like London, where they are harder to detect. Foreign central banks also hold the securities of government-sponsored agencies like Freddie Mac and Fannie Mae, although they have trimmed those holdings since the subprime crisis. If by purchasing U.S. Treasury bonds foreign central banks can lower U.S. interest rates by as much as a full percentage point, then they could, by curtailing those purchases, presumably raise U.S. rates by a corresponding amount. The U.S. housing market and construction sector would feel the pain. This would be a not-so-subtle way for China to make known its displeasure with U.S. policy toward North Korea or Iran, or with a U.S. Treasury decision to label China a currency manipulator. The benefits that America derives from Chinese purchases of U.S. debt are a factor in the State Department’s reluctance to push Beijing harder on human rights issues and the Treasury Department’s reluctance to push it harder on the exchange rate issue. In principle, China could go further and sell its previous purchases. Given the magnitude of its holdings, this would cause bond prices to crater and U.S. interest rates to spike. Smaller bond market shocks than that have caused financial mayhem in the United States. Consider the 1.5 percent rise in thirty-year Treasury yields that occurred in 1994 when Japanese investors faced with a financial crisis at home sold off their U.S. holdings. The result was serious losses and fears of insolvency of major financial companies and hedge funds. If the Chinese wished to wreak havoc in U.S. financial markets, this would be the way. The deterrent to China’s doing so is that it might also be wreaking havoc in its own markets. When institutional investors in Japan sold off some of their U.S. treasuries in 1994, driving down the price, they suffered losses on their remaining holdings. This heightened concern about the solvency of not just U.S. financial firms but Japanese financial institutions as well. China would face an analogous problem. Eichengreen goes on to outline reasons such behavior would create problems for China's economy, so no need to get alarmist. The article as a whole raises a series of interesting discussion points on the impact of the dollar's global status on the U.S. economy and business. Read The Once and Future Dollar here . (Hat tip, Greg Mankiw )

The euro hit a two-month high against the dollar earlier this week, prompting some to wonder whether the currency is overvalued at the moment. Time will tell, but the ups and downs of the currency are nothing new. To mark moments in the young currency's history when it has been overvalued, INSEAD 's Antonio Fatas charted the dollar/euro exchange rate against the Purchasing Power Parity. (Note: Fatas used the German mark to estimate what the value of the euro would have been had the currency existed before 1999): Fatas: The Euro has fluctuated from a high value of 1.59 in July 2008 to a low value of 0.59 in February 1995. Are these numbers comparable? Not quite. Currencies are expressed in nominal terms so they are likely to move over time when inflation rates are not the same in both countries. In this particular case, we have witnessed an upward drift of the Euro over the years because inflation was on average lower in Europe. This trend can be captured by estimates of Purchasing Power Parity (PPP), in red in my chart. But even when we take into account this trend, the value of 0.59 in 1985 was a significant undervaluation of the Euro (the German Mark then) in comparison to PPP (around 0.95). Same for July 2008, the value of almost 1.6 represented a large overvaluation of the Euro relative to its PPP value (below 1.2). We also see in the chart that episodes of overvaluation or undervaluation relative to PP are persistent. A strong Euro in the late 70s was followed by a very weak Euro during most of the 80s. During the 90s the Euro was in general above PPP estimates. Before the official launch of the "real" Euro in 1999, the German Mark was already heading down and this trend continued leading to another episode of undervaluation of the Euro. An episode that was stopped by a join intervention of the US Fed and the ECB in November 2000. Since then the Euro became stronger and stronger until it reached its peak of 1.6 in July 2008. So, Fatas sees the euro as overvalued today, though not at an historically unprecedented level. Read The overvalued Euro here .

Martin Feldstein is not a big fan of the euro. He says that European leaders who pushed for a single currency did so in spite of history and "economic logic" that showed it was not a good idea. As for the argument that the dollar works for the US and EU, like the US, is a made up of many smaller economies with varying rules, he rejects the comparison. At Project Syndicate , Feldstein writes: First, the US is effectively a single labor market, with workers moving from areas of high and rising unemployment to places where jobs are more plentiful. In Europe, national labor markets are effectively separated by barriers of language, culture, religion, union membership, and social-insurance systems. To be sure, some workers in Europe do migrate. In the absence of the high degree of mobility seen in the US, however, overall unemployment can be lowered only if high-unemployment countries can ease monetary policy, an option precluded by the single currency. A second important difference is that the US has a centralized fiscal system. Individuals and businesses pay the majority of their taxes to the federal government in Washington, rather than to their state (or local) authorities. When a US state’s economic activity slows relative to the rest of the country, the taxes that its individuals and businesses pay to the federal government decline, and the funds that it receives from the federal government (for unemployment benefits and other transfer programs) increase. Roughly speaking, each dollar of GDP decline in a state like Massachusetts or Ohio triggers changes in taxes and transfers that offset about 40 cents of that drop, providing a substantial fiscal stimulus. There is no comparable offset in Europe, where taxes are almost exclusively paid to, and transfers received from, national governments. The EU’s Maastricht Treaty specifically reserves this tax-and-transfer authority to the member states, a reflection of Europeans’ unwillingness to transfer funds to other countries’ people in the way that Americans are willing to do among people in different states. Read Europe is Not the United States here .

Europe has its euro problems. But it has dollar problems as well. Like most of us, European banks don't have enough dollars. In the latest Marketplace Whiteboard , Paddy Hirsch explains why European banks need US capital, even though they have their own currency:

Hong Kong-based Next Media came on the international scene when they produced a short animated film of a certain golfer crashing his SUV when there was no footage for the event (which for some reason was the most important news story for a lot of "news" outlets). Their latest effort tackles a very different sort of issue--the currency battle between China and the US. And for this story, they give us an animated rap battle. And we think the G20 summit might get a bit more widespread attention if this were how global leaders debated differences. Just sayin' (viewer discretion is advised--language in the rap may go over the line for some):

The German government has made a major market move, and the markets moved in response. Last night, German authorities put a ban on certain types of short selling into effect. From the Financial Times report: The German action against naked shorting – or selling securities such as shares and bonds that are not owned or borrowed – comes amid heated discussion in Europe of regulatory curbs on speculative trading, which has been widely blamed by politicians for exacerbating the Greek debt crisis. Bafin, Germany’s financial regulator, said the ban was needed because of the “exceptional volatility” in eurozone bonds and the considerable widening of spreads on credit default swaps. Large-scale short-selling could have “endangered the stability of the entire financial system”, Bafin said. The ban, which would be effective immediately and last until the end of March next year, would be regularly scrutinised, Bafin said. It would apply to eurozone sovereign bonds and credit default swaps as well as the shares of a group of 10 leading German financial stocks. After the news, the Euro, already at a four year low against the dollar, dropped again. Read Germany moves against short sellers here .