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.
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