Simmering Currency Wars

by Patrice Hill at Washington Times:

While the United States has been fussing at China for gaining an advantage in trade by depressing the value of its currency, other nations — while agreeing about China — are increasingly focused on the falling dollar and concern that the U.S. may be doing the same thing.
Treasury Secretary Timothy F. Geithner on Wednesday stepped up U.S. demands that China stop closely controlling the value of its currency and allow it to rise against the dollar, suggesting that the Asian giant may be violating its pledge last year to move toward freer exchange rates with other Group of 20 economic powers.
"We have moved aggressively to do our part to help bring the world out of crisis," said Mr. Geithner, noting Congress' enactment of strict new regulatory reforms on Wall Street this summer, and a big drop in the U.S. trade deficit since 2008 as a result of greater savings and less spending by U.S. consumers.
While not mentioning China specifically in his speech to the Brookings Institution, Mr. Geithner pointed to what he described as other "major economies" with chronic large trade surpluses and undervalued currencies, in an unmistakable reference to the Asian giant.
European nations echoed Mr. Geithner's criticism in a separate forum with Chinese Premier Wen Jiabao in Brussels, and called on China to allow more rapid appreciation of its currency, the yuan or renminbi. That prompted a strong rebuke from the Chinese leader.
"Do not work to pressurize us on the renminbi rate," he said. "Yes, we are going to proceed with the reforms," but he suggested the bigger problem for the world economy was the recent large drop in the U.S. dollar, which is the world's main reserve currency.
Mr. Wen warned of dire consequences if China were to abandon its gradual currency reform and allow a rapid rise of the yuan.
"Many of our exporting companies would have to close down, migrant workers would have to return to their villages," he said. "If China saw social and economic turbulence, that would be a disaster for the world."
But the United States. received strong backing in its dispute with China from an important quarter — the International Monetary Fund. In a report Wednesday, the IMF urged China and other Asian nations with large trade surpluses to stop devaluing their currencies, rely less on exports for growth and encourage more consumer and business spending at home.
While the IMF expects the world economy to keep growing this year — led by double-digit growth in China and other developing countries — it warned that the resumption of distorted trade patterns that prevailed before the recession could undermine the economy once again.
The recovery is "neither strong nor balanced and runs the risk of not being sustained," said Olivier Blanchard, the IMF's chief economist. He added that the threat of a downward deflationary spiral in the United States, Japan and other developed nations remains viable.
Renewed economic weakness in the United States this summer — and the Federal Reserve's vow to fight a relapse into recession with even looser money policies — set off a rapid drop in the dollar against other free-floating currencies. Since August, the dollar has lost 8 percent of its value against the euro, and is down by 5 percent against major world currencies.
The dollar's rapid decline has provoked a chain reaction in other countries, ranging from a decision by Australia not to raise interest rates this week to a forceful intervention in currency markets to support the dollar by Japan and a dramatic move by the Bank of Japan to slash interest rates to zero this week.
Because the U.S. dollar is the world's dominant currency, it is taking center stage along with the spat with China at the run-up to an IMF meeting in Washington this weekend as well as a G-20 meeting planned in Seoul next month.
Brazil's finance minister created ripples in financial circles by suggesting last week that the decline of the dollar was setting off an "international currency war." Brazil itself has imposed taxes on hot money coming across its border in an attempt to stem the rapid rise of its own currency, the real.
With the U.S. and most other nations vowing to offset weakness in their own economies by trying to increase exports, some analysts fear that the kind of competitive devaluations that erupted during the Great Depression could be in the offing.
"Beggar thy neighbor is back," said Harm Bandholz, economist at Unicredit Markets. He said the U.S., Japan and United Kingdom are all deliberately weakening their currencies to try to gain an advantage in trade. The Obama administration has set the goal of doubling U.S. exports in five years.
But Raghav Subbarao, analyst at Barclays Capital, says he doesn't see a currency war on the horizon just yet, though he expects the G-20 meeting to be especially tense as nations sound off about their currency grievances..
"It would clearly be impossible for every country to follow a policy of competitive devaluations simultaneously," he said, but the temptation is there because the U.S. and other developed nations seem to have reached the limits of using fiscal and monetary policies to try to stimulate their economies.
With interest rate already at or near zero, "governments are increasingly turning to exchange rate policy as a means to maintain or improve their competitive positions," he said. That means the risks of a currency war, "although quite low, are increasing," he said.