Friday, October 08, 2010

Currency war looms?

Business Times - 09 Oct 2010

Currency war looms?

US and Beijing politicians will need a lot of political courage to take economic steps that could prevent a new currency and trade war


AS finance ministers and central bankers from around the world gathered in Washington for the annual IMF and World Bank meetings, everyone was talking about the same topic - and it is not the weather.

To paraphrase Karl Marx: a spectre is haunting the global economy - the spectre of brewing currency wars. Unlike the talk over weather, when it comes to the exchange rate problem, economic officials suggest that they actually know what to do about it. Unfortunately, they seem to want the other guys to walk the walk, while they continue talking the talk.

The 'central existential challenge facing the world economy', is the way US Treasury Secretary Timothy Geithner described the currency issue last Wednesday. 'We believe it's very important to see more progress by the major emerging economies to more flexible market-oriented exchange rate systems,' Mr Geithner explained in his address before the Brookings Institution, a Washington-based think tank.

Guess who is the culprit that needs to make progress in the direction of 'more flexible market-oriented exchange rate systems', that Mr Geithner was referring to? If you haven't guessed, here is another hint from Mr Geithner's address: The problem facing the global economy was 'large economies with undervalued exchange rates', he said.

Mmm ... was he talking perhaps about China?

That is clearly not the way Chinese leaders see the problem. Forcing China to revalue its currency would bring about 'disaster to the world', is the way Chinese Premier Wen Jiabao put it after meeting with European Union (EU) officials in Brussels also last Wednesday, where he took part in an EU-China summit where the main focus was - surprise! surprise! - the currency issue.

Reflecting the view of the politically powerful managers of China's exporting sector, Mr Wen argued that a speedy rise in the value of the yuan could lead to the collapse of China's export industry, devastating the Chinese economy and the entire global economy.

The perception among many US officials and lawmakers who blame Chinese manipulation of its exchange rate as part of an export promotion strategy is that it provides Chinese exporters an unfair advantage against American producers.

The result is, according to the conventional wisdom on Capitol Hill where lawmakers are already threatening China with sanctions, a devastation of American manufacturing, high unemployment, and a slower recovery of the US economy. And that is dragging down the entire global economy, they stress.

Since the Sino-American debate over China's currency policy seemed to have reached a stalemate, the Obama Administration - as Mr Geithner made it clear - is now trying to 'internationalise' the issue, hoping to win support from other economies and multilateral institutions led by the International Monetary Fund (IMF) to put pressure on China to revalue its currency.

The problem is that when Chinese act to keep their currencies from appreciating, it encourages other economies to do the same, Mr Geithner noted. Indeed, there has been an increase in the number of countries, including Japan and Brazil, to follow in the footsteps of the Chinese and keep their currencies lower as a way to help them move towards speedy economic recovery, setting the stage for what could become a currency war.

Countries around the world are driven to get currencies down as far as they can in value so that they can export their way out of the recession, a never-ending vicious circle of currency devaluations, igniting asset bubbles and inflation and creating the conditions for another global financial meltdown.

Indeed, there are signs that other economies such as South Korea, Taiwan, Thailand, Peru and Colombia are joining this race to the bottom.

There is no doubt that the heads of the IMF are worried about the potential for this type of currency war. Indeed, IMF managing director Dominique Strauss-Kahn warned on Thursday that many governments were pursuing devaluation policies that would boost their immediate economic fortunes. But, such policies would damage the global economy in the long-term. There can be 'no domestic solution to a global crisis', he stated during a press conference.

But, it is unlikely that the IMF could play the UN-mediator-type role in the currency showdown between China and the US or that the institution would be able to force the Chinese to change their policies. Mr Geithner seemed to suggest on Wednesday that increasing China's leadership role in the IMF (where the US is the largest shareholder) would depend on Beijing's willingness to adopt more flexible exchange rates.

At the end of the day, the issue will have to be resolved through negotiations between China and the US with the other members of the G-20 grouping playing an assisting role. After all, as everyone knows by now, both China and the US need to adjust their domestic economic policies in a way that would make it possible to rebalance the global financial system where China remains a huge surplus economy that mirrors the gigantic American deficit economy.

But unfortunately, Washington is continuing to pursue expansive fiscal policies and a loose monetary approach that leads to increasing the debt that China is buying. China in turn, accumulates large US dollar reserves and sterilises its interventionist currency policy in a way that helps reduce Chinese consumption and savings and boosts Chinese exports.

Untangling this web requires negotiations between China and the US that would come about after the two governments recognise that they would have to pursue coordinated monetary policies involving the central banks and treasury ministers of the major surplus and deficit economies, and that as part of this strategy, they would have to make choices that could run against powerful political interests in their respective countries.

However, there is no sign that politicians in either Washington or Beijing are ready to take those economic steps that would require a lot of political courage, but could prevent a new currency and trade war.

Copyright © 2010 Singapore Press Holdings Ltd. All rights reserved.

1 comment:

David Wozney said...

Re: “... a never-ending vicious circle of currency devaluations, ...

If the stated value, of “Federal” Reserve notes, declines enough with respect to copper and nickel, the 1946-2010 U.S. Mint nickels, composed of cupronickel alloy, could become somewhat rare in mass circulation.

The October 8th metal value of these nickels is “$0.0617794” or 123.55% of face value, according to the “United States Circulating Coinage Intrinsic Value Table” at