The slanging match over currency and
monetary policies at the annual Fund-Bank meetings, held over the second
weekend of October, points to the disarray in global economic governance.
While the US sought to mobilise IMF support for an effort to realign exchange
rates and ensure an appreciation of the renminbi in the wake of China's
reserve accumulation, the Chinese accused the US of destabilising emerging
economies by allowing ultra-loose monetary policy to flood the emerging
world with money. The result was that there was little agreement on what
needs to be done to drag the world out of stagnation.
Evidence mounts that the much-touted recovery from the Great Recession
of 2008 is yet to gather steam, and unemployment in the developed world
remains at intolerable levels. On the other hand, there is still no consensus
on how to deal with the problem. Governments in the developed countries
are clearly overcome by ''stimulus fatigue''. Having used up a substantial
part of the head room they had for deficit spending to bail out the financial
sector, and having accumulated much debt in the process, there is scepticism
about continuing with a fiscal stimulus. So, increasingly, the push for
recovery is moving in two directions. One is the resort to ''quantitative
easing'', or the injection of liquidity into the system through lending
by central banks, especially the US Federal Reserve, at near zero interest
rates. The other is to increase pressure on emerging market economies,
especially China, to allow their exchange rates to appreciate, in the
hope that it would expand US exports to and reduce its imports from those
markets and facilitate a recovery.
The simultaneous advocacy of these two options is a sure recipe for conflict.
It is widely accepted that the injection of cheap money into the developed
economies is resulting in financial firms borrowing cheap at home to invest
in emerging markets for profit, with little contribution to domestic recovery
in the developed world. Emerging markets, on the other hand, are witnessing
a capital inflow surge that is not merely triggering speculative booms
in stock and real estate markets, but also exerting upward pressure on
their currencies. To expect them, therefore, to allow their currencies
to appreciate further would be preposterous. In fact, despite efforts
to use some capital controls to limit inflows as well as resort to open
market purchases of foreign currencies by the central bank to absorb surplus
foreign exchange in domestic markets, countries like Brazil have not been
able to prevent appreciation of their currencies.
China, however, is a potential target for the currency baiters because
of the trade and current account surpluses it runs and the reserves it
has accumulated. This provides the basis for declaring that the country
is manipulating its currency in mercantilist fashion to sustain growth
at the expense of the rest of the world, especially the US and Europe.
Most recently, the US House of Representatives has passed, with a 348-to-79
majority, a bill that allows the country to impose countervailing duties
on imports from China. Those duties are to be calibrated using estimates
of the extent of ''undervaluation'' of the renminbi, to signal that, in
the US' view, China is manipulating its currency for export gain and generating
global current account imbalances in the process. This round of China
bashing has been justified by referring to the evidence that while China
unpegged the renminbi from the dollar in June this year, the currency
has appreciated only marginally. Thus, the accusation is not that China
is resorting to devaluation, but that it has not ''permitted'' adequate
appreciation despite its trade and current account surpluses, especially
vis-à-vis the United States.
What is surprising is that the House has resorted to this move despite
evidence that in the past, and even today, intervention in various forms
to prevent currency appreciation or even ensure depreciation of currencies
has been the norm. The United States, which protests much today, had exercised
its global economic and political power to ensure the depreciation of
the dollar vis-à-vis other leading currencies, especially the Japanese
yen, through the Plaza Accord of 1985. A year and a half later, it engineered
the Louvre Accord to prevent further decline of the dollar. Currency manipulation
is an old G8 practice. Most recently, the Bank of Japan intervened in
its currency market to purchase 20 billion dollars in return for Japanese
yen allowing it to stabilize an appreciating currency and ensure its depreciation
from 83 yen to the dollar to around 85 yen to the dollar. Since the Japanese
economy is still in deflationary mode, the injection of liquidity into
the system to manage the currency does not stoke fears of inflation.
Japan's decision to intervene does weaken the legitimacy of the attack
on the renminbi implicit in the US bill and of the pressure being mounted
by the G20 on China to ensure further appreciation of the renminbi. However,
while Japan's move has indeed been criticized by many of its trading partners,
dissent is muted because of the recognition that Japan has suffered for
long from a recession that was triggered in part by developments flowing
from the appreciation of the yen consequent to the Plaza Accord.
Given its governance structure, it is not surprising that the IMF has
joined this chorus. In its view, the sharp divergences in growth or uneven
development in the global economy calls for a process of ''external rebalancing,
with an increase in net exports in deficit countries and a decrease in
net exports in surplus countries, notably emerging Asia. This, in turn,
is seen as requiring a realignment of currencies involving ''greater exchange
rate flexibility'', with an appreciation of the Chinese renminbi, for
example, and a relative depreciation of the dollar and the euro.
There are a number of issues this argument glosses over. To start with,
uneven development is an essential characteristic of capitalism, and in
the past, for centuries, today's developed countries were the winners
in a process that polarised the world into the developed and underdeveloped.
Underlying that polarisation was the consolidation of a division of labour
wherein the developed were the producers of productivity-enhancing manufactured
goods and the underdeveloped were left to live off the technologically
less dynamic primary products that were losing out in world trade. What
we have been observing in a gradual and limited manner over the last three
decades is a partial reversal of this process, with a few emerging markets
having turned winners in the trajectory involving uneven development.
Secondly, as economist Prabhat Patnaik has argued, this shift in favour
of emerging markets has been the outcome of the nature of recent processes
of globalisation in which capital and technology have flowed easily across
borders, while labour movement has been far less flexible and increasingly
more limited. Since past processes of development have ensured that some
of the more populous countries of the world (including China) were left
with underutilised labour reserves, this differential in ease of cross-border
movement led to the flow of capital in search of the cheap labour reserves
in those parts of the developing world. This has not only changed the
pattern of uneven development, but since highly productive modern technology
now combines with the cheap surplus labour in these countries, it results
in a rise in the surpluses or profits garnered from production and therefore
to inadequate- or under-consumption that depresses overall global output
and employment growth. It must be noted that among the beneficiaries of
this distorted process are also firms from the developed countries that
seek to locate production facilities in these low-cost, labour surplus
economies, and produce for world markets including the markets of their
countries of origin. Yet their role rarely receives the attention it deserves
in discussions of global imbalance.
Finally, given these drivers of contemporary uneven development, adjusting
any one currency, such as the renminbi, is unlikely to redress the global
imbalances. It would at most merely shift the balance of payments surpluses
to other countries with labour reserves that would now become the new
hubs for world market production.
Despite all this, since countries that are the target of capital inflows
are finding it difficult to prevent the appreciation of their currencies,
the US and Europe are receiving explicit or implicit support for the China-bashing.
Central banks from many other countries have been and are intervening
in currency markets to hold down the value of their currencies, but have
not been all too successful. This is true, for example, of South Korea,
India, Malaysia, Taiwan, the Philippines and Singapore. Their moves have
received global attention ever since Guido Mantega, Brazil's finance minister,
declared that a currency war had broken out in the global economy. ''We're
in the midst of an international currency war, a general weakening of
currency. This threatens us because it takes away our competitiveness,''
Mr Mantega reportedly said. In doing so he was being disingenuous because
Brazil's immediate problem is not the weakening of the currencies of its
competitors but the strengthening of the Brazilian real, which has been
identified as one of the world's most overvalued currencies.
In fact ''overvaluation'' that affects export competitiveness adversely
seems to be the factor accounting for currency market interventions by
central banks in most countries. The explanation for such ''overvaluation''
is the surge in foreign capital flow to these countries in the period
between 2003 and the Great Recession and once again over the last one
year. Intervention to address the excessive strength of individual currencies
is costly since the reserves accumulated by buying foreign currency have
to be invested in liquid financial assets that offer very low yields,
while the foreign investors bringing in the dollars that lead to appreciation
of the local currency earn substantially high returns. Moreover, for countries
that do not have the ''advantage'' of low inflation and low interest rates,
the problem can be never-ending. Thus, in India, for example, increases
in interest rates aimed at combating inflation are resulting in further
inflows and a substantial strengthening of the rupee.
The implications are clear. The resort to monetary easing in the developed
counties, with another round of such easing expected in the US after figures
pointing to the loss of 95,000 jobs in September were released, is triggering
a boom in the ''carry-trade''. Financial investors borrow cheap in dollars
and put their money in emerging markets to earn high returns. In the event,
emerging market countries unwilling to impose controls on capital inflows
experience a capital surge and invite an appreciation of their currencies.
Since such appreciation undermines their export competitiveness, they
are forced to intervene in currency markets to limit or reverse such appreciation.
To justify this costly way of dealing with the problem created by fluid
capital flows, they point their fingers at other countries which are preventing
currency appreciation. China comes in useful here, not just because it
severely limits appreciation, but because it is a successful exporter
and records current account surpluses. Thus, joining the American clamour
against China becomes a way of deflecting attention from the fact that
the failure to export enough stems from an inadequacy of domestic policies
rather than the aggressive currency moves of others. This ''currency war''
blame game makes the prospect of progress on formulating a coordinated
recovery plan in the G20 summit at Seoul next month extremely dim.