1. What would happen if Brazil allowed the real to float freely in FX markets:
If the government did not intervene to weaken the real to around R$2, I suspect the real would be much stronger. This would propel imports and also capital inflow into the country due to the high interest rates. Since the government wanted to make Brazil competitive for exports, a weak currency would dissuade companies from exporting since they would earn less in revenue for every $ exported. Further with a free currency and no capital controls, the ease of investing and removing capital would make the Brazilian stock market (which as it is, is very small) more susceptible to foreign capital. ...view middle of the document...
With a strong real, there was a good chance that buyers abroad would search for alternative suppliers (in other countries) who were cheaper.
a. Was any other country fighting such a war?
There were several other countries such as China, Colombia, Switzerland, Japan who were taking similar measures in an attempt to have stable & competitive currencies. The most controversial among them was China, which had a fixed float until G20 meeting in September. Pressure from other countries (US in particular) forced China to allow a 2% appreciation in yuan.
b. What were the weapons? Why?
Brasil used a mixed of tools such as direct government intervention, imposition of capital controls (taxes on inflows on bonds & stocks) and quantitative easing (indirectly). The quantitative easing would lower long term interest rates and thereby dissuade foreign investment.
c. What benefits do they expect?
Currency war was initiated to respond to action taken by other trading partners (China, which was crucial for Brasil) and also to react to the monetary easing by US. Since US dollar is a reserve currency of the world, any policy change in the US (quantitative easing, change in monetary policy) has global effects on international trade and deficits of...