A relatively new phenomenon of currency wars has reappeared on the economic horizon of world trade. Currency has come to be recognized as a potential weapon, and more and more countries are resorting to this instrument to safeguard their individual interests. The late re-appearance of currency war, which had earlier surfaced in the 1930s, had its genesis in the US's hot pursuit to seek de-freezing of Yuan. The US alleged that this was the reason for the undue price advantage of Chinese products in the world market, rendering products from other countries, including the US, out-priced. India, too, had felt the heat, as echoed in previous issues from time to time.
How does a Currency War Start?
A "currency war" is more of a political than an economic condition. Governments frequently intervene in their currency markets, increasing the money supply to stimulate trade and reduce unemployment, or decreasing the supply to combat inflation. The problem is that in an interlinked global economy, currencies don't rise or fall in a vacuum. When China keeps the Yuan artificially low versus the U.S. dollar, it keeps the cost of Chinese goods low in the United States, contributing to a trade imbalance. That provides a steep incentive for the United States to retaliate by lowering its currency as well. Of course, because two countries can only have one exchange rate, this race to the bottom isn't likely to benefit either party.
When many countries devalue their currencies simultaneously to make their exports more competitive, it forces other countries, like Brazil, for instance, to join in to prevent their currencies from rising. However, the widespread devaluation can have a devastating effect on all. Unstable exchange rates can deter international investment, slowing the pace of global economic recovery.
Tit-for-tat
Unilateral action by one central bank can, therefore, set off or fuel reactions in other parts of the world. In this game of three-dimensional chess, countries are forced into tit-for-tat action. On September 27th, Brazil's Finance Minister Guido Mantega warned that the "international currency war...threatens us because it takes away our competitiveness." Brazil would not stand idly, he said. And so, the cycle of currency intervention threatens to continue. For Charles Dallara, Head of the Institute of International Finance, representing the world's big banks, the issue risks setting off a new round of protectionism. In a letter to the IMF, he urges the world's leading economies to get a grip on the problem. "Addressing exchange rate issues should also be a key priority for multilateral negotiations among a core group of major economies," Dallara wrote.
But the major economies seem in no mood for compromise. The US said that the IMF "has a very important role to play" in trying to get multilateral cooperation on currency intervention. Yet, US Treasury Secretary Timothy Geithner has pumped $600 billion into the US economy.
Although America sees itself as a victim of global currency intervention, many people argue that its own policies are the cause. The Governor of Taiwan's central bank, Perng Fai-Nan, said last month: "The US printed a lot of money, so there's a lot of hot money flowing around. We see hot money in Taiwan and elsewhere in Asia. "These short-term capital flows are disturbing emerging economies," he said. Joseph Stiglitz, the Nobel Economics Laureate, agrees: "The irony is that the [Federal Reserve] created all this liquidity... It's doing nothing for the American economy, but it's causing chaos over the rest of the world." Whether or not the US started the problem, most observers believe it has the lead role in trying to resolve it.
Dr Paola Subacchi, Research Director for International Economics at Chatham House, in London, said: "Rather than China-bashing, the US should lead efforts to coordinate exchange rate policies and put the issue on the global agenda... The US sets the pace on currency issues." But a resolution will not happen overnight. What's more, the problem is likely to get worse before it gets better.
G20 Finance Ministers Resist US Pressure over Trade
The G-20 is trying to find a coordinated path out of the financial crisis. US proposals that countries set targets to reduce trade imbalances appeared to be running into opposition at the G-20 meeting of leading economies.
Getting Beijing to tackle its large trade surplus would be an indirect way of forcing the Yuan to rise in value. In his letter to G-20 colleagues on the opening day of a meeting of finance ministers in South Korea, Geithner said countries should aim to reduce surpluses or deficits to a targeted share of gross domestic product. US officials said the target would be 4% of GDP by 2015. China's current account surplus was 4.9% of GDP in the first half. Japanese Finance Minister Yoshihiko Noda summed up the mood among other big exporters, including Germany, saying Geithner's proposal was "not realistic". Australian Treasury Secretary Wayne Swan said he was not sure a "one-size-fits-all" approach could work.
Common approach
The G20 finance ministers tried to find a coordinated path out of the financial crisis and avert what some leaders have called "currency wars". Many countries have been happy to see the value of their currencies fall, as it boosts their export competitiveness. The US has accused Beijing of resisting upward pressure on the Yuan by buying dollars, thereby making America's exports to China more expensive. However, China has expressed unhappiness at what it sees as foreign interference in an internal matter.
Lamy Warns Against Upsetting Global Financial Stability
WTO Director General Pascal Lamy said the fight over currency values could upset global financial stability. The head of the World Trade Organisation has warned countries against keeping their currencies undervalued to create jobs, saying such policies could spark a return to 1930s-style protectionism. Pascal Lamy said the fight over currency values- in a reference to the United States and China- could upset global financial stability.
Generating employment "is at the heart of the strategy of some countries to keep their currencies undervalued", Lamy said in New Delhi. "Just as it is also at the heart of other countrie's loose monetary policies". Competitive devaluations, which have raised fears of a global currency war, could trigger tit-for-tat protectionism, he told. Lamy singled out unsustainable and socially unacceptable unemployment levels around the world as the most serious challenge facing the global economy. But uncoordinated beggar thy neighbour policies will not result in increased employment, he said.
The United States, where unemployment is nearly 10 per cent, has been accused of doing the same with a $600 billion cash injection announced earlier this month as it seeks to jump start its sluggish economy. Lamy also said he was aiming for a preliminary deal in the stalled Doha round of WTO trade talks by mid-2011. He said the Group of 20 advanced and emerging economies summit in Seoul called for negotiations across the board to conclude the end game" of the global trade liberalisation talks in 2011.
Failure to reach an agreement would weaken the only institution which governs the rules of world trade and could lead to "unilateralist, populist policies which discriminate against foreign workers and goods", Lamy warned. For a sustainable global recovery, "economic evidence tells us that opening to international trade" is better for growth and jobs than being a closed economy, he said and warned against efforts by nations to achieve a trading advantage similar to moves that worsened the Great Depression of the 1930s. "The lessons of history are there, showing that it is coordinated action through international cooperation that maximises benefits for citizens of the world", Lamy said.
Efforts to end the currency wars have not yet produced results. In late October, G-20 finance ministers agreed to abstain from devaluing currencies and promised to transition to market-based exchange rates. However, countries with reserve currencies have not pursued a coordinated monetary policy. If they had, the United States would not be able to inject $600 billion into its economy.
With their actions, the key players in the world economy have indicated that it's every country for itself. For years, America has demanded that China let its currency appreciate, as a weak Yuan gives Chinese exporters an unfair competitive advantage. U.S. Treasury Secretary Timothy Geithner repeated that China cannot continue to resist the upward market pressure on the Yuan without facing higher inflation. Secretary Geithner apparently sees no contradiction in criticizing China for keeping the Yuan artificially low while the Federal Reserve pursues the exact same policy.
Currency wars broke out in the fall of this year, when many countries-from the United States and Brazil to South Korea and Thailand-started artificially devaluing their currencies to make their exports more competitive and to attract investors with cheaper assets. They resorted both to direct interventions on the currency market and indirect measures, such as pumping liquidity into their national economies.
India Chills at its Own Peril
Far away from madding crowds and the currency war scenario, India seems to be cool and chilling, as if these events hardly are relevant to it. It is unfortunate. In fact, India is already feeling the heat, but seems to be pretending as if it does not matter. It does, to my mind.
As was pointed in our last issue of The Stitch Times, "the soaring appreciation of Indian Rupee in recent past has been unprecedented and one reason which has made a major contribution to this, has been the massive inflow of FII funds, which has already crossed $ 23 billion so far in the current calendar and is still counting. In fact, the country's rapid economic growth and rising interest differentials with the West, which continue to follow easy monetary policy, have attracted huge capital inflows in pursuit of higher returns, leading to precipitation of a sharp Rupee appreciation."
It would be, therefore, wrong to think that the currency war that is now going on, does not impact India, or Indian exports, including garment exports. To my mind, with the recent mercurial rise and fall of Indian Rupee, which I strongly believe, is due to what has been termed as "hot money" and the massive injection of $ 600 billion by the US, Indian exports are suffering and would continue to suffer, despite the lip-service that the Government of India offers from time to time by reaffirming its so-called commitment to promote Indian exports including and particularly garment exports.
Views presented here are that of the author.
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