The global “currency war” first highlighted by Brazilian finance minister Guido Mantega on September 27 is showing little sign of abating. Finance ministers attending the IMF meetings in Washington DC failed even to pretend they had poured oil on the crisis, which now looks certain to spill over the G20 meeting in Korea.
Monday’s Bloomberg headline said it all: “Finance Chiefs Fail to Resolve Currency Spat as G20 Splits.” The financial news service reported that the Washington meetings had been dominated by talk of exchange rates and protectionism, amid concern that many countries are deliberately debasing their own currencies in order to prop up domestic growth while “risking retaliatory devaluations and trade barriers”.
China is everybody's favourite villain, and stands accused of undervaluing the yuan through its longstanding dollar peg. For its part China accuses the US of destabilizing the Chinese and other emerging economies by allowing ultra-loose monetary policy to flood the emerging economies with capital. Meanwhile the US would like the IMF to focus on exchange rates and reserve accumulation by China.
Some see this as part of a wider “race to the bottom”. The Telegraph’s Ambrose Evans-Pritchard recently warned that the current era of "universal currency debasement” poses some serious risks for the global economy suggesting gold is the only safe haven at such uncertain times.
The “beggar thy neighbour” battles being played out on the currency markets are in marked contrast to the global co-operation seen in the immediate aftermath of the crisis – notably the ubiquitous faith in Keynesian-ism seen at the G20's London Summit in April 2009. Elizabeth Stephens, head of credit and political risk at London-based insurance broker Jardine Lloyd Thompson summarized how things have changed.
"Even a year ago, [the G20 countries] thought they needed each other. Now, it's survival of the fittest."
The Wall Street Journal’s Alen Mattich said that countries’ attempts to export themselves out of their difficulties through competitive devaluations is bound to end in tears. And he was none too flattering about the current generation of central bankers, who he said have
"consistently erred on the side of fecklessness, excess and imprudence. When inflation starts to show up, it will be in the form of a generalized, global price pressure which central bankers will ignore as exogenous and outside of their control … there is every reason to believe that the upshot of this global round of currency debasement will be rampant and uncontrolled inflation rather than just a slightly higher rate for a temporary period. Indeed, this is what the surging gold price is telling us will happen."
Barry Eichengreen, professor of economics at University of California (Berkeley) agrees that central bankers are the biggest current obstacle to a saner economic world. He said most are stuck in the past and “still fighting the last war”. He reserved his deepest venom for the European Central Bank which he accused of still obsessing about defeating an already-defeated enemy – inflation – while ignoring its real current enemy – deflation.
Writing in Foreign Policy Eichengreen said all three of the world's big central banks – the Federal Reserve, the ECB and the People's Bank of China – must show better leadership. The Fed should stop dithering and clarify the extent of the quantitative easing it intends. The People's Bank of China should allow the yuan to appreciate in order to modestly cool off and rebalance its economy toward domestic demand. The Frankfurt-based institution “needs to start planning for the next battle instead of incessantly fighting the last." Eichengreen added,
"If it ends up with an exchange rate of $1.50 to the euro, the European economy tanks, and in the absence of growth the Greek, Irish, and other fiscal austerity programs will collapse. It will only have itself to blame. Here's a prediction: Contrary to what the markets currently assume, the ECB will eventually join the quantitative easing bandwagon. The only question is whether by the time it does it will already be too late.”
Other commentators are more worried about what the Obama administration and Ben Bernanke's Fed might get up to. They say that, if the US were to commit to the full-scale currency war by unleashing the nuclear bomb of further quantitative easing, it would be disastrous for everyone. This would “widen the economic imbalances that lie at the root of our problems," argues Peter Schiff, chief executive and chief strategist at Euro Pacific Capital:
"The US dollar would continue to plummet in value as it would become clear to foreign creditors that the Fed had lost interest in protecting their investments. A weaker dollar would lead to higher inflation and higher interest rates… In the end, America’s bubble economy will not just deflate, it will burst."
So what is the solution? Pimco’s Mohammed El Erian believes it is essential that the IMF is given new powers so it is capable of slapping down errant central bankers. A related solution would be for the current generation of central bankers to simply "grow up" and recognize that there are more mature and longer-term ways of ensuring domestic prosperity and of resolving the world's economic imbalances. After all, the current round of competitive devaluations are only going to make these worse.
Further reading on currency wars and the world economy:
- Viewpoint: Augusto Lopez-Carlos What Would a New Bretton Woods Mean for the IMF?
- Viewpoint: Roger Bootle How to Rescue the World Economy From Disaster
- Why Printing Money Sometimes Works for Central Banks by Paul Kasriel
Tags: central banks , China , economic recovery , European Central Bank , G20 , global imbalances , international differences , protectionism , US