The threat of a currency war is obviously a major topic at the G20 summit in Seoul, South Korea, on November 11-12.
Currently, most developed countries are still mired in economic slowdowns, while emerging economies have managed to secure heightened growth rates. Room for more aggressive fiscal stimulus in developed economies such as the United States, the EU and Japan is limited due to rising fiscal deficits and government debts. And the sovereign debt crisis in the euro zone has certainly done nothing to alleviate the economic unease. Now, they are scheming to propel economic development through monetary policy adjustments, which involves depreciating their own currencies or forcing emerging economies to appreciate theirs.
Hoping to boost exports, the United States, EU and Japan announced successive rounds to quantitatively ease their monetary policies.
Emerging economies aren't without problems of their own—concerns about inflation are rampant due to the economic rebound from the financial crisis. And as developed countries mostly adopt zero-interest rate policies, these measures are pushing emerging economies into a corner of appreciation. For instance, Brazil's benchmark interest rate stands as high as 10.75 percent, causing the Brazilian real to appreciate more than 30 percent against the U.S. dollar, the fastest appreciating currency in the world.
Central banks in emerging economies like Brazil, India, South Korea, Thailand, Malaysia and Russia have interfered with the currency exchange markets out of fear of an export slump caused by the currency appreciation. The interference has not gone unnoticed, as developed countries are pointing fingers and accusing emerging economies of manipulating their currencies. Emerging economies in turn have argued developed countries are using loose monetary policies to trigger depreciations of their currencies.
The world economy is at a crossroad where all countries are trying to keep their currencies competitive to spur exports. Already, the scenario bears a striking resemblance to the currency war in the 1930s following the Great Depression—and that currency war only managed to push the world deeper into recession. A currency war, if breaks out now, is likely to play out the same way.
A very bad idea
Although disputes over currency policies are on the rise, the situation is far from being an actual currency war, said Zhou Yu, an expert on international finance and currency at the Shanghai Academy of Social Sciences.
Zhou said all countries must strive to prevent a currency war, since an open conflict would only spell disaster for the world economy.
A currency war, Zhou said, would first increase the risk of inflation. If other countries blindly follow the U.S. method of quantitative easing, this "herd mentality" would trigger a rampant flow of liquidity. Judging from past experiences, the depreciation of the U.S. dollar will inevitably prop up the value of raw materials, crude oil and agricultural products, which will cause cost-driven inflation. In the second half of 2010, the U.S. dollar's depreciation has led to a substantial increase of wheat, corn and cotton prices by 50 percent.
The inner stability of the international monetary system would also be shattered, Zhou said. The fluctuation of the U.S. dollar has a huge impact on international financial stability. At present, more than 60 percent of the reserved currencies of central banks around the world are in U.S. dollars, and 50 percent of international settlement is done using the U.S. currency. If the dollar depreciates dramatically, economies using the dollar as a settlement or reserve currency will face heavy pressures.
What's worse, a currency war could escalate into a global trade war. As it stands, it will be nearly impossible for developed countries to increase their exports through currency depreciation as many emerging economies are interfering with the currency exchange markets. Under these circumstances, developed countries tend to adopt protectionist measures, such as threats of trade sanctions, to force emerging economies to appreciate their currencies.
No matter the cause, a currency war will increase the risks facing emerging economies. The U.S. monetary policies could lead to large capital inflows into emerging economies as the yields in emerging markets are much higher than those of developed countries. In turn, if those countries tolerate the dollar depreciation, their external trading conditions will take a beating. But if they interfere with their foreign exchange markets and prevent their currencies from appreciating, their inflation risk and capital bubble will throw their economies into a financial abyss. Once the U.S. Government raises interest rates, the large capital outflow will likely trigger a financial crisis in emerging markets.
But Zhou has faith in today's decision makers, noting that they are much wiser today when dealing with currency and trade-related issues because they can draw references from the past.
Developed countries, led by the United States, are alleging the undervalued Chinese currency, the yuan, is the culprit for China's huge trade surplus. The United States also blames China for its dwindling exports and rising unemployment. And a growing number of U.S. politicians are pressuring China to appreciate its currency.
Wang Yuanlong, an expert from the Hong Kong-based Tianda Institute, refuted the U.S. allegations, citing other reasons for the China-U.S. trade imbalance. The trade surplus, he said, was caused by differences in industrial division between the two countries. The service sector contributes about 80 percent to the U.S. GDP, with manufacturing making up only 11 percent. In China, the opposite is true, with manufacturing accounting for 60 percent of GDP.
RMB not the answer
Trade in goods contributes less than a quarter to China-U.S. economic cooperation; the rest lies in the service trade. The United States exports as much as $20 billion in services—for instance, investment banks conducting initial public offering for Chinese companies—to China each year; about 50,000 U.S. banks, insurance companies, auditing firms and law firms have operations in China with annual sales revenue of $220 billion.
"Trade between China and developed countries are supplementary to each other. A substantial appreciation of the yuan will not help U.S. employment, but will force the United States to seek imports from other emerging economies," Wang said.
Differences in calculations between the two countries have also caused disputes in terms of trade value. The U.S. calculation overestimates its deficit with China in four ways. First, it applies different statistical standards to imports and exports. It tends to overestimate the value of imports and underestimate the value of exports. Second, the United States adds the "Made-in-China" products it imports from other regions or countries to imports from China, while excluding its exports to China via Hong Kong or other regions, which contributes to the trade imbalance. Third, when calculating its trade value with China, the United States only uses commodity trade data but excludes the value of services it exports to China. Fourth, a large number of Chinese products are exported to the Caribbean and Latin American regions via the United States; and these products, too, have been included into China's export figures to the United States.
Since China started the reform of the yuan exchange rate regime in July 2005, the yuan has risen 23.5 percent against the U.S. dollar. From January 1994 to July 2010, the Chinese currency rose 55.2 percent against the U.S. dollar. But the U.S. trade deficit continued to expand in the same period.
"Those who claim the yuan is undervalued deliberately disregard the fact that the yuan has appreciated substantially since the reform began. Their insistent allegations clearly have other intentions," said Wang.
Yao Jian, spokesman of the Ministry of Commerce, said on October 15 that China had no intention of pursuing a trade surplus in its international trade. During the financial crisis, China's imports from the United States, the EU, Japan, Australia and South Korea rose about 50 percent respectively. China's import growth rate, Yao said, was twice the speed of China's exports to those countries and regions.
Trade surplus
The United States, Yao said, had a trade surplus for 93 years before the 1980s—China has only had a trade surplus for a little more than 10 years. More importantly, China's surplus with the United States is mostly generated by foreign-funded or foreign-owned companies in China, which produce nearly 88 percent of Chinese exports to the United States. Those foreign investors have taken away the lion's share of profits.
"If China held a surplus of $10, $1 or $2 of it goes to China, but $7 or $8 goes to foreign-funded companies, mostly established by American, European and Japanese companies," said Yao. "It's utterly irrational [for the United States] to hold the yuan as the scapegoat for its own national problems," he stressed.
On the Chinese side, the yuan does not have a solid foundation for substantial appreciation.
"The center of the conflict is that the United States wanted to depreciate the dollar, but was met with resistance from other economies. How things develop in the coming months depends on whether the United States changes its mind," said Andy Xie Guozhong, an independent economist and a director at Rosetta Stone Advisors Ltd. "Although the value of the dollar is close to its lowest point in history, the U.S. Government is still pushing for further depreciation."
Right now, the belief among U.S. political leaders is that depreciating the dollar will help boost employment, Xie said. But this is just wishful thinking; the hovering unemployment rate is due to the fact that private companies are reluctant to hire new employees in these uncertain economic times.
"The only benefit of dollar depreciation is a slight increase in U.S. exports, but then inflation will come along. If other countries refuse dollar depreciation, and follow suit to print more money, worldwide inflation is inevitable," said Xie. "Right now, it all depends on the United States," he added.
Many U.S. politicians think that printing more greenbacks to depreciate its currency is totally reasonable and rational, but it is utterly unacceptable for other countries to do the same. Xie said the double standards were too obvious.
Ultimately, dollar depreciation cannot salvage the U.S. economy. The U.S. Federal Reserve has slashed its benchmark interest rate to nearly zero, and the government budget deficit has risen to 10 percent of the GDP. After a recovery for several quarters, the U.S. economy is declining again with the unemployment rate nearing 10 percent.
"If you're Paul Krugman, you'd probably say the current stimulus is not powerful enough. You might suggest raising the budget deficit to 20 percent of GDP, and another round of quantitative easing," Xie said.
"What it all comes down to," Xie said, "is that depreciating currencies for export growth is a zero-sum game."
An end in sight?
How will this round of the currency dispute wrap up? Zhang Ming, an international finance expert at the Chinese Academy of Social Sciences, pointed out three possibilities.
First, the governments of all countries could reach a new Plaza Accords—an agreement reached by developed nations in 1985 to intervene in currency market—with the Chinese Government agreeing to appreciate its currency substantially in the next few years. Second, the Chinese Government could completely refuse currency readjustment, resulting in a trade war with the United States. Third, after international negotiation, the Chinese Government could agree to increase the flexibility of the exchange rate regime, but maintain control over the pace of the yuan appreciation.
Without a doubt, China's interests would be damaged by the first scenario. The second scenario will make both countries sink together. The third is the best, and most difficult, option but requires wisdom and candid cooperation from all leaders and countries.
But no one can argue a currency war is the last thing politicians want. At the G20 financial ministers and central bank governors' meeting held in South Korea on October 21-23, a joint communiqué was released, saying they would move toward more market-determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies.
The joint communiqué also noted their commitment to taking action at the national and international level to raise standards, so that national authorities implement global standards consistently, in a way ensuring a level playing field and avoiding fragmentation of markets, protectionism and regulatory arbitrage.
The currency disputes have highlighted the predicament the global currency system is facing: the dollar, a sovereign currency of the United States, also serves as an international reserve currency. The two functions are actually contradictory. If the U.S. Fed starts to print more money to spur its economic development, a dollar flood will sweep the world, causing huge damage to international financial stability. Therefore, it's time to establish a new monetary system, said Cao Yuanzheng, chief economist at BOC International (China) Ltd.
"The current global reserve currency is still the U.S. dollar. But its fluctuation has led to volatility in other currencies. A new international monetary system must be built or the existing one will collapse for good. Major economies should collaborate on this front to rebuild the international economic and monetary order," said Cao.
Developed countries' low interest policies
United States: In the first half of this year, the U.S. Federal Reserve withdrew part of its stimulus measures. But confronted with a recovery slowdown and impotent fiscal stimuli, the Fed started a new round. In July, it announced buying U.S. Treasury securities; in August, it ordered a cut to the excess reserve requirement ratio. A report issued by the Board of Governors of the Federal Reserve System on October 12 said the United States will keep the interest rates low and might start the second round of quantitative easing monetary policy, which means the Fed buys treasury securities and institutional bonds to inject liquidity into the market, to spur an economic revival.
Japan: The Bank of Japan, the country's central bank, slashed its benchmark interest rate from 0.1 percent to 0.1-0 percent to hold back the yen's appreciation. It is the third time for Japan to have a zero interest rate after 1999-2001. At the same time, Japan's central bank pledged to build a temporary fund of up to $60 billion to buy government bonds which is similar to the U.S. quantitative easing monetary policy.
Europe: The Bank of England decided to keep its key interest rate at 0.5 percent—the lowest level in history. The European Central Bank announced it would keep the key interest rate at 1 percent—also the lowest in history.
Australia: On October 7, contrary to most economists' forecast of an interest rate hike of 25 basis points, the Australian central bank announced to keep the current 4.5 percent rate to offset the Australian dollar's fast and passive appreciation against the U.S. dollar.
《Beijing Review》2010 NO. 44 NOVEMBER 4, 2010
