The fact that an IMF meeting ended with the participants unable to feign a narrowing of differences on the currency front is further evidence that positions are hardening. And let us put none too fine a point on this: the currency row is simply an acceptable way to fight over imbalanced trade patterns.
As we pointed out in a 2007 post, “The Dangers of Overselling, and Overdoing, Global Trade“:
Dani Rodrik…makes the point that globalization fans may be their own worst enemy by taking the simpleminded point of view that if globalization is good, more globalization is of course better. Rodrik reminds us that globalization needs to be balanced against national interests, and some of the nations touted as big beneficiaries of more open trade markets, such as India and China, in fact did not open their markets to imports until their growth rates were increasing handily.
His most important observation is “If there is one lesson from the collapse of the 19th century version of globalisation, it is that we cannot leave national governments powerless to respond to their citizens.” Yet some of the proponents believe in the sovereignity of markets, that any attempt to intervene in markets will only yield bad outcomes, and will in any event be futile because the forbidden activity take place despite the barriers we try to erect (hhm, if we really believed that, we wouldn’t be using economic sanctions against Iran, now would we?).
It’s similar to an argument made by William Greider in a New York Times article, “The Truth Deficit,” in which he makes the case that the system we operate under isn’t free trade, it’s managed trade, and most other countries play the game in a way to produce better national outcomes (fewer lost jobs and trade surpluses). We seem to be running our trade policy not to optimize our national interest, but that of large international corporations, which is far from the same thing.
Yves here. The threat to a system with a high level of international trade is the existence of large players who run persistent surpluses. That requires that someone, perhaps lots of someones, are in the position of running large trade deficits, which also entail rising domestic debt levels. When the debtor nation gets tired of playing this role (which can come about for a host of reasons), its new found religion forces adjustments on its trade partners.
For the US, reducing our trade deficit really means reducing imports of manufactured goods. That ultimately also means increasing exports, but that will take a longer time to put into effect, assuming the US multinational vogue for offshoring can be partially reversed. Before readers start haring on how cheap labor is in Bangladesh, recall that factory labor is only 10% of the final sales cost of most manufactured goods, and sending work overseas involves some offsets (transit time, which reduces flexibility, higher managerial/coordination costs, need to finance a longer production cycle). So in many industries, more flexible, just in time manufacturing could have been competitive in quite a few sectors. The real reason for the loss of jobs isn’t so much worker cost as lack of management imagination and resourcefulness (how fashionable is it in the US these days to be in a manufacturing business? “Talent” wants to be on Wall Street or in Silicon Valley).
Bloomberg presented the battle lines:
Exchange rates dominated the IMF’s annual meeting in Washington on concern that officials are relying on cheaper currencies to aid growth, risking retaliatory devaluations and trade barriers. China was accused of undervaluing the yuan, while low interest rates in the U.S. and other rich nations were blamed for flooding emerging markets with capital…..
At the same time, officials from emerging economies including China complained that low interest rates in the U.S. and its developed-world counterparts mean investors are pouring capital into their markets, threatening growth by forcing up currencies and inflating asset bubbles.
The Financial Times gives an even uglier assessment:
Global economic co-operation was in disarray and further battles in the currency war looked likely after the weekend’s international meetings of finance ministers and central bankers broke up with no resolution.
The world’s largest economies remained as far apart as ever on currencies. China accused the US of destabilising emerging economies by allowing ultra-loose monetary policy to flood the emerging world with money, while the US insisted the International Monetary Fund should intensify its focus on exchange rates and the reserve accumulation of China.
The lack of any substantive agreements and brinkmanship on proposed reforms to the IMF is likely to exacerbate currency volatility in the month running up to the Seoul Group of 20 summit.
Some Fed defenders may contend that its super lax strategy is simply because the central bank is trying to forestall deflation with the only tool it has at hand. By contrast, Ambrose Evans-Pritchard argues that the Fed’s QE2 strategy is aimed at countries that are suppressing the value of their currencies:
Asian investment in plant has run ahead of Western ability to consume. The debt-strapped households of Middle America, or Britain and Spain, can no longer hold up the dysfunctional edifice. Asians must take over, or it will come down on their own heads.
The countries actively intervening in exchange markets to suppress their currencies – China, Japan, Korea, Thailand, even Switzerland, to name a few – are all too often the same ones that have the biggest trade surpluses with the US.
They are taking active steps to prevent America extricating itself from the worst unemployment since the Great Depression, now 17.1pc on the latest U6 index and rising again.
Each country is doing so for understandable reasons: Japan to avoid a deflationary crisis, China to hold together a political order that is more fragile than it looks. In both these cases they are trapped because they clung too long to a mercantilist export strategy, failing to wean themselves off American demand when the going was good.
Yet this is an intolerable situation for the US. It should be no surprise that Washington has begun to retaliate in earnest, and not just by passing the Reform for Fair Trade Act in the House (not yet the Senate), clearing the way for punitive tariffs against currency manipulators.
The atomic bomb, of course, is quantitative easing by the Federal Reserve. America has in effect issued an ultimatum to China and G20: either you stop this predatory behaviour and agree to some formula for global rebalancing, or we will deploy QE2 `a l’outrance’ to flood your economies with excess liquidity. We will cause you to overheat and drive up your wage costs. We will impose a de facto currency revaluation by more brutal and disruptive means, and there is little you can do to stop it. Pick your poison….
Devaluation was not the mistake of the 1930s: it was the cure, albeit a bad one. The Gold Standard broke down during the inter-war years because the US and France had structurally undervalued exchange rates (like China/Asia today) and ceased recycling their trade surpluses (like China/Asia today). This caused a deflationary downward spiral for everybody.
Escaping from such a deformed system was a path to recovery. The parallel with modern globalization – though not exact – is obvious. So is the 1930s lesson that currency and trade clashes are asymmetric: they are calamitous for surplus countries, but not always for deficit countries. Britain enjoyed a five-year mini-boom after retreating into an Empire trade bloc in 1932.
As much as China backers are loath to hear it, big creditor nations (the ones in the position of China) suffer worse in the wake of financial crises than debtor countries. That hasn’t happened so far because China has dumped a ton of liquidity in its economy to drive domestic investment to unheard-of levels, nearly 50% of GDP. In addition, it has kept the renminbi pegged to the falling dollar, enabling it to maintain its trade surplus at the expense of other exporters, notably Japan. It’s been able to delay a day of reckoning, but the end game is approaching.
Update 8:00 AM: This Tim Duy post is an important addition, please be sure to read it in its entirety. The summary:
Bottom Line: The time may finally be at hand when the imbalances created by Bretton Woods 2 now tear the system asunder. The collapse is coming via an unexpected channel; rather than originating from abroad, the shock that sets it in motion comes from the inside, a blast of stimulus from the US Federal Reserve. And at the moment, the collapse looks likely to turn disorderly quickly. If the Federal Reserve is committed to quantitative easing, there is no way for the rest of the world to stop to flow of dollars that is already emanating from the US. Yet much of the world does not want to accept the inevitable, and there appears to be no agreement on what comes next. Call me pessimistic, but right now I don’t see how this situation gets anything but more ugly