The truth about the Currency Wars

Over the past few weeks there has been much discussion about so-called ‘currency wars’ among nations. Japan, Brazil and South Korea, among others, have taken steps to try to depress the value of their currencies in recent weeks, so as to try to make their exports cheaper and more competitive in world markets.

At the same time, the US turned up the volume of its long-standing complaint against China for not allowing the value of its currency, the yuan, to appreciate. To back up this charge, the US House of Representatives passed a bill with bipartisan support at the end of September that permits the US to levy tariffs on China and other countries that they contend undervalue their currencies.

It has at times appeared that the US is the only country that feels strongly about China’s currency policy. Consequently, the US has more recently sought to obtain wider international support for its position, but the US failed to obtain such support at the annual meetings of the International Monetary Fund (IMF) and the World Bank last weekend. As the New York Times reported, the meetings ended ‘with a tepid statement that made only fleeting and indirect references to the simmering currency tensions’. Following the meetings, the US vowed to increase the pressure on China, and the debate will continue at the G20 meeting in Seoul in November.

‘Currency wars’, like trade wars, are potentially very destructive if they get out of control. By definition, this ‘war’ must have winners and losers: not everyone can depress their currency’s value and increase their exports. In the 1930s, nations sought advantage by depressing their currencies to try to improve their competitiveness. As historian Charles Kindleberger noted in The World in Depression: ‘As with exchange depreciation to raise domestic prices, the gain for one country was a loss for all. With tariff retaliation and competitive depreciation, mutual losses were certain.’

Both developed and developing parts of the world are engaged in these currency ‘wars’, but they are motivated to do so for different reasons. In the West, the recovery has been sluggish, and Western countries have pumped huge amounts of money into their economies to try to overcome it. This puts downward pressure on their currencies, and increases their hopes of improving exports. Emerging economies, in contrast, are growing faster than Western ones, and capital is flowing into their countries (especially in Asia and Latin America), which places an upward pressure on their currencies. But they worry that the rise in currency value will be so rapid that it will damage their export-led growth strategy, and so they seek to suppress that upward pressure.

It was notable how the major nations could not agree on a way forward at the IMF and World Bank meetings. Like the US, the developed economies are concerned about China’s unwillingness to let the yuan rise in value. But they are just as opposed to seeing the US dollar falling, which has happened recently, because it hurts the value of their own currencies. In particular, they observe that the Federal Reserve’s easy-money policies – with interest rates nearly at zero and massive expansions in money supply – are pushing the US currency down.

At the same time, most are not as anti-China as the US is. The other big powers note that China announced in June that it will allow the yuan to rise gradually over time, and indeed this has happened in practice, albeit slowly. Moreover, the developed countries recognise that they cannot simply slap down emerging economies like China and understand that these economies must have their say. This is a further sign that the US’s period of unipolar dominance is eroding.

It was striking how the world’s leaders at the IMF meetings recognized that a currency war was a problem, but would not take responsibility for their own actions. Instead, they sought to pass the buck and blame others.

The discussion over currency wars is often dominated by US criticisms of China. Superficially, it looks like the US has a valid case. China’s intervention – by means of purchasing dollars and adding them to its reserves – is one of the heaviest in absolute terms. But what the US administration and Congress fail to point out is that, considering the size of its economy, China’s intervention is relatively small. And, while recognising that China’s actions are deliberate and significant, it still doesn’t mean the country should be singled out for blame. The fact is that most countries – including the US – manipulate their currencies in one way or another.

The US’s argument against China’s currency interventions is not based on its intellectual merits; it is a self-serving attempt to get out of its slump at the expense of China. As in the 1930s, we see that conflicts over currencies are born out of desperation in a low-growth or negative-growth environment.
Clive Crook recently wrote in the Financial Times that now is the ‘time to get tough with China’. He explained: ‘If the equilibrium rate of unemployment has risen, scope for remedial monetary and fiscal policy is diminished. Which leaves getting tough with China.’ As this quote shows, getting tough with China is based on the exhaustion of traditional counter-crisis measures, and a pessimistic view of the possibility of improvement.

The way to relieve these pressures driving towards destructive currency wars is to focus on the positive rather than the negative – on growth. The US, in particular, would be better served by focusing on getting its own economic house in order before resorting to scapegoating China. A lower yuan will not address the US’s issues of competitiveness. What China exports to the US, the US typically no longer manufactures; and while a lower dollar will help sell more goods in China and elsewhere, it won’t be enough to turn around the large trade deficit.

Improving competitiveness requires taking a harder look at the economic fundamentals that drive growth. Blaming others is a distraction from that difficult but essential task.

Sean Collins is a writer based in New York. Visit his blog, The American Situation, here.