Tag Archives: currency wars

Beijing’s Currency Wars Playbook

Beijing will play its usual defense against the moves in the U.S. Senate to twist China’s arm to appreciate its currency against the dollar: vociferous denunciation of Washington for turning protectionist and initiating “trade wars” while patiently waiting out the start of any serious hostilities, calculating that the threat of them will eventually recede.

The denunciation has duly come with Foreign Ministry spokesman, Ma Zhaoxu, saying the bill now in front of the U.S. Senate proposing punitive measures against any country that is shown to be manipulating its currency — for which read China — “seriously violates rules of the World Trade Organization and obstructs China-U.S. trade ties”. He told U.S. Senators to abandon protectionism and stop politicizing economic issues. He also told them to “stop pressuring China through domestic law-making”. Co-ordinated sentiments have been expressed by the central bank and the commerce ministry.

While perhaps nobody outside the U.S. Congress really believes that a sharp revaluation of the yuan on its own will eradicate America’s trade deficit with China or create the new domestic jobs the U.S. is having such trouble generating, Beijing will know that even if the Democratic majority in the U.S. Senate passes the bill, the legislation will likely founder in the Republican controlled House of Representatives. Even if it does not, it is highly unlikely to survive a presidential veto. That is the past pattern of such proposed legislation. Support for this year’s bill appears to be stronger, helped by its narrower provisions and the background of sluggish U.S. growth and joblessness, but the odds remain long that it will become law.

At the very worst from China’s point of view, and the bill does become law, it will be cheaper politically for Beijing to fight any punitive measures through the WTO than it would to be seen to capitulate to foreign pressure. Meanwhile, it can bide its time, letting the gradual appreciation of the yuan that has been underway since June last year (up 7% against the dollar since then and 10% against the euro) ease the U.S. pressure, which is anyway likely to abate after next year’s U.S. elections. Simultaneously, it buys more time for the economy, particularly the export-manufacturing sector, to adapt.

China’s policymakers are quite happy for the yuan to appreciate. It will help them both fight inflation and restructure the economy. They just want do it to their timetable, not Washington’s–and they have the playbook to do that.

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Beijing Heeds The Lessons Of Japan’s Yen Revaluation

As G-20 finance ministers and central bankers meet in Seoul to call a verbal truce at least in the currency wars, Bloomberg has a piece noting that China has taken note of what happened to Japan after the 1985 Plaza Accord led to the rapid appreciation of the yen against the dollar.

A short history lesson for younger readers: Following the accord between what was then the G-5 to depreciate the dollar against the yen and the mark, the dollar fell by 51% against the yen between 1985 to 1987. Japan’s exports shrank, unemployment rose, cracking the system of lifetime employment at the large conglomerates, and the economy slowed dramatically — the endaka fukyo, high-yen recession. The cutting of interest rates to get the economy going again led to the asset bubbles which, after they inevitably went pop, left the country mired in debt, which in turn has left the Japanese economy becalmed in the still waters of recession and deflation ever since.

Now Japan made policy mistakes and had a political and social system designed to absorb external shocks rather than effect change when change was needed, so the analogy only goes so far, but Beijing doesn’t want to go anywhere near there in the first place. Hence its determination to let its own currency appreciate only gradually.

There are two other lessons from Japan’s experience in the 1980s that won’t have escaped the notice of China’s leaders. First, it was Japan’s huge current account surpluses that had given it the global buying power in the 1980’s that made the country “No 1” and raised a scare among developed nations, particularly the U.S., that Japan was taking over the world and would eclipse the U.S as the world’s leading economy. When the current account surpluses disappeared, Japan’s emerging clout on the world stage evaporated with it. Second, what happened to Japan’s economy after the Plaza Accord led eventually to the long-ruling Liberal Democratic Party lose its monopoly grip on power.

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China Turns Down U.S. Currency War Offer It Was Always Going To Refuse

As this Bystander expected, prospects for the G-20 calling a truce in the currency wars seem remote. Reuters news agency is reporting that China, India and Germany are rejecting out of hand a U.S. proposal to set numerical targets for trade surpluses and deficits at the G-20 finance ministers meeting in Seoul this weekend.

The American proposal would put far too much flesh for the taste of the surplus nations on the bone of a mom-and-apple-pie agreement among the G20 a year ago that big surplus countries like China would aim to shift growth away from being export led while the big deficit economies like the U.S. would seek to boost domestic savings. We expect the communiqué to be issued after this weekend’s meeting will be long on good intentions but short on any agreed measures — let alone commitments — to make good on them, not the ideal preparation for the G-20 leaders’ summit next month.

This post was first published on Market Bystander.

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U.S. Treasury Dodges Declaring China A Currency Manipulator

The U.S. Treasury is mandated by law to issue a report every six months on whether any country is manipulating its currency for an unfair trade advantage. Although, or more likely because the exchange rate between China’s yuan and the U.S. dollar, is so political charged now, the Treasury has booted down the road taking a decision on whether to declare China a currency manipulator as charged by so many in the U.S. It says it will wait not just until after the U.S. mid-term Congressional elections on Nov. 2nd, but also the Seoul summit meeting of G-20 leaders on Nov.11 and the Asia Pacific Economic Cooperation forum summit on Nov. 13-14. Those meetings may come to some agreement, though we think that unlikely, so the U.S. Treasury’s delay looks like a Hail Mary pass while its scrambles, to mix a metaphor, to take a policy high-road:

The challenge of building a stronger, more balanced and sustainable global economic recovery is a multilateral challenge, not just the responsibility of China and the United States.  It requires policy reforms in all major economies.

We know that is right, but good luck with that anyway.

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U.S. Vs China; Dollar Vs Yuan; Inflation Vs Deflation

The leaders of the G-20 nations will meet next month in Seoul to attempt to defuse tensions over competitive devaluation by governments — the currency war of the tabloid headlines — that their central bankers and finance ministers were unable to resolve at last weekend’s annual meetings of the International Monetary Fund and the World Bank. At this point the prognosis is not good. The consensus and cooperation that was there at the start of the global financial crisis continues to evaporate.

Host South Korea, as Japan’s finance minister has mischievously pointed out, is one of the countries that “regularly” intervenes in foreign exchange markets, but it is China’s foreign exchange-rate policy that will be the elephant in the room, as it was at the IMF meeting. The pace of the yuan’s appreciation against the U.S. dollar since China again loosened its peg with the greenback in June (2.4%) has been insufficient for the critics who accuse China of keeping the yuan cheap to protect its exporters.

If China’s most recently posted trade surplus of $120.6 billion dollars in the first nine months of 2010, 10.5% lower than in the same period a year earlier, hasn’t assuaged China’s critics, then the largest quarterly increase in the country’s foreign exchange reserves in the third quarter, $194 billion, thanks to the persistently large trade surplus and capital inflows, is only likely to inflame them, providing further evidence that the yuan is undervalued.

The new factor is the beggaring of neighbours. U.S. Treasury Secretary Timothy Geithner says that that the yuan’s undervaluation is forcing other developing countries that supply China to attempt to halt the appreciation of their currencies, too. What Geithner did not say was that it halting his country’s attempts to devalue its way to export growth, too. For those with even longer memories than ours, the calamitous competitive devaluations of the Great Depression come into prospect.

Beijing has been candid about the damage it believes a rapid upward revaluation of the yen would to do its exporters, citing that as its reason for moving cautiously. It continues to remind anyone who will care to listen, though its words mostly fall on deaf ears in the rich countries, that there are other sources of the current global imbalances, such as huge fiscal deficits and unconventional monetary policy in the developed economies.

We are likely to be hearing more of that refrain. In the U.S., the Federal Reserve is expected to embark soon on another wave of flooding the U.S. economy with money, the so-called second round of quantitative easing (“QE2”). The Fed’s strategy for stimulating a recovery that is stubbornly sluggish, if not unexpectedly so given the de-leveraging the U.S. economy has undergone, is to inflate the economy and depreciate the dollar by a combination of running negative real rates (nominal rates are already as close to zero as makes no difference) and quantitative easing.

This is not with our risk. So much world trade is denominated in dollars, as the only global reserve currency, that price inflation of commodities like oil is inevitable. That may not worry Americans so much (yet; but wait for $200 crude), as fighting off deflation is their immediate concern, but it sure worries emerging economies that are not natural-resources exporters, such as China, where inflation is the more pressing concern.

The double hit that quantitative easing in developed economies lands on emerging economies is that it will increase their inward capital flows, potentially inflating asset bubbles, making more probable further intervention in foreign exchange markets to forestall that. The Institute for International Finance forecasts net capital inflows into emerging economies of more than $800 billion in 2010 and 2011.

Governments usually respond to such potentially disruptive capital inflows with some mix of the three policy tools they have available to them: intervention in foreign-exchange markets; the imposition of taxes and controls on the capital flows directly; or doing nothing–letting their currency appreciate and take the hit to their export competitiveness. Neither is a particularly palatable choice, particularly for export-driven emerging economies. We are likely to see all three in some form if the “currency wars” continue.

The long-term solution is well-known,  high-spending, high-deficit developed economies need to get their fiscal houses in order while the real exchange rates of the surplus economies need to appreciate and domestic demand expanded to offset the effect on exports. Getting there is the difficult part.

Not only has the journey barely begun, the kids are already bickering in the back seat. Instead of the sort of co-operation among governments that marked the early days of the global financial crisis to coordinate an orderly adjustment of exchange rates and external accounts (pace the IMF pulling an unlikely rabbit out of the hat before the G-20 summit), each is starting to go its own way. The U.S. is resorting to the instant creation of money, as it uniquely can as it has the world’s only reserve currency (oh, that we could all increase our bank accounts at the touch of a button as the Fed can). China is resisting in the way it knows best, controls, in this case on its exchange rate by having its central bank tightly manage the bands in which the yuan can move.

At the same time, China’s leaders, who have a historic fear of inflation and who know well what it can do for ill to the country’s rulers, believe that the way to make the underlying adjustments to real exchange rates that everyone agrees is necessary long-term is through falling domestic prices in the U.S. That would be similar to the sort of deflationary austerity on the U.S. that is being wished on Greece. That may not be politically acceptable in the U.S. any more than inflation would be politically acceptable in China. But inflating away the world’s global imbalances vs deflating them away are fundamentally opposite policies. The standoff between the two is worsened because deflation in the U.S. would be as bad for China as inflation in China would be for the U.S.

Both threaten to send the global economy into reverse. That all makes a G-20 agreement on exchange rates ever more necessary as a dampener on rising protectionist spirits in the developed economies and the rising nationalism in China among those who see the economy as primarily a matter of national security.  When elephants fight, as the Swahili saying goes, the grass gets trampled. Unfortunately, that doesn’t make an agreement in Seoul any more likely. The best that can be hoped for is that the grass will be left in good enough condition to spring back up again.

This post was first published on Market Bystander.


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