Currency chaos threatens global recovery
Martin Khor
A new 'currency war' is said to have broken out. Unless quickly
resolved, it can have a severe effect on the global system.
The past few weeks have seen the emergence of global currency chaos,
which is a new threat to prospects for economic recovery.
In fact, the situation is being depicted by the media and even by
some political leaders as a "currency war" between countries.
The rates of currencies all around the world are fluctuating at
a rapid and unknown speed |
The general idea being conveyed by this term is that some major
countries are taking measures to lower the value of their currencies in
order to gain a trade advantage.
If the value of a country's currency is lower, then the prices of its
exports are cheaper when purchased by other countries, and the demand
for the exports therefore goes up.
On the other hand, the prices of imports will become higher in the
country, thus discouraging local people from buying the imports.
The result is that the country will get higher exports and lower
imports, thus boosting local production and improving the balance of
trade.
The problem is that other countries that suffer from this action may
"retaliate" by also lowering the value of their currencies, or by
blocking the cheaper imports through higher tariffs or outright bans.
Thus, a situation of "competitive devaluation" may arise, as it did in
the 1930s, which can contribute to a contraction of world trade and a
recession.
The present situation is quite complex and involves at least three
inter-related issues.
First, the United States is accusing China of keeping the yuan at an
artificially low level, which it claims is causing its huge trade
deficit with China. A US Congress bill is asking for extra tariffs to be
placed on Chinese products.
China claims that such a measure would be against the WTO's rules,
and that a sudden sharp appreciation of the yuan would be disastrous for
its export industries, nor would it solve the problem of the US trade
deficit.
Japan, whose yen has appreciated sharply against the dollar,
intervened on the currency market on 15 September by selling 2 trillion
yen in order to drive its value down.
And then Japan criticized South Korea for taking the same
intervention measure to curb the appreciation of the won.
Second, there are clear signs that the United States is preparing to
lower the value of its dollar, through a new round of "quantitative
easing", in which the Federal Reserve will spend probably hundreds of
billions of dollars to buy up government bonds and other debts.
(However, seen as a move to tamper such fears, the US Treasury Secretary
Timothy F. Geithner assured that there is no move to further weaken in
the US dollar, according to news reports - TWNF).
This will increase liquidity in the market, which would reduce
long-term interest rates (and thus contribute to a recovery).
* But this would also have two other effects. It would weaken the US
dollar further (thus opening the US to the accusation that it is also
engaging in competitive depreciation).
* And the new liquidity would also add to a surge in capital flowing
out of the US (where returns to investment are very low) to developing
countries.
* In the past, such surges of "hot money" would have been welcomed by
the recipient countries.
* But many developing countries have now learnt, through the hard
way, that sudden and large capital inflows can lead to serious problems,
such as:
* The capital inflow will lead to excess money in the country
receiving it, thus increasing the pressure on consumer prices, while
fuelling "asset bubbles" or sharp rises in the prices of houses, other
property and the stock market. These bubbles will sooner or later burst,
causing a lot of damage.
* The large inflow of foreign funds will build up pressures for the
recipient country's currency to rise (against other currencies)
significantly.
Either the financial authorities would have to intervene in the
market by buying up the excess foreign funds (which is known as
"sterilization") and thus build up foreign reserves or allow the
currency to appreciate this and have an adverse effect on the country's
exports.
* Experience (including of the Asian crisis of 1997-99) shows that
the sudden capital inflows can also turn into equally sudden capital
outflows when global conditions change. This can cause economic
disorder, including sharp currency depreciation, loan servicing problems
and balance-of-payments difficulties.
* At the last International Monetary Fund annual meeting in
Washington, there was a conflict of views between the United States
(which accused China of deliberately suppressing the value of its yuan
and not allowing it to appreciate more) and China (which accused the US
of planning quantitative easing and increasing liquidity to deliberately
devalue its currency).
* Meanwhile, even serious Western analysts and newspapers have
recognized the threat posed to developing countries by large inflows of
capital coming from the developed countries in search of higher yield.
* In an editorial on October 15 entitled 'The Next Bubble, the
International Herald Tribune warns that Wall Street is snapping up the
assets of emerging economies. Describing the problems caused by huge
inflows of capital, it asked the developing countries to "pay close
attention" and to "consider capital controls to slow inflows."
* This is the third recent development: some developing countries
have introduced capital controls to slow down the huge inflows of
foreign capital.
The Institute of International Finance estimates that a massive
US$825 billion will flow to developing countries this year, an increase
of 42 percent over last year.
* Brazil has doubled the tax on foreigners buying local bonds, while
Thailand recently imposed a 15 percent withholding tax on interest and
capital gains earned by foreign investors on Thai bonds. South Korea has
warned of new limits on forwards, while banks are asked not to lend in
foreign currency.
Finally, there are fears that if the currency chaos or currency war
is not solved soon, the world faces the threat of trade protectionism,
whether it takes the old form of an extra tariff, or a new form of
competitive currency depreciation.
Moreover, the quantitative easing that the US is now planning may
exacerbate the speculative flows of funds in search of profits, and this
can be destabilizing to the recipient countries and the global economy
overall. - Third World Network Features. |