The underlying cause for the currency war is to be traced to the phenomenon of global imbalance

Co-operation among nations to solve common economic problems has never been as hard to comeby as the following developments show.

The term ‘currency war' was first used by the Brazilian Finance Minister to describe the competitive debasement of fiat money. Individual countries perceive a competitive advantage in keeping the value of their currencies low.

But quite obviously, such competitive depreciation cannot go on indefinitely. Sooner than later, whatever advantage that may accrue initially will get dissipated. The currency war has global dimensions: it is not just one or two countries which suffer, but the global economy. There can never be any victors in this currency war. In the 1930s, the ‘beggar-thy-neighbour' policies followed by many countries impoverished them and ultimately the global economy.

Globalisation

Since then, the level of interconnectedness among countries has increased tremendously. The phenomenal growth of the financial markets is matched only by the large scale adoption of technology and globalisation. There is every reason why countries should co-operate among themselves. Important institutional structures have, in fact, been created to nurture co-operation. The World Trade Organization, for instance, aims to further the development of rule-bound multilateral trade. The IMF and its Bretton Woods twin the World Bank have been given well defined roles. Both these institutions have played their part, though not always, to everyone's satisfaction. Recently, the G-20 has taken over the role of managing the global economy as it were. The G-20 represents a broader cross-section of the world's leading economies than the original G-7, which represented only the rich countries.

But the point is that with so many structures and perhaps more importantly the realisation that co-operation, even collaboration rather than confrontation is the way forward there should not be a disturbing phenomenon such as the currency war. It is obvious that solutions to these lie only if countries adopt a spirit of give and take.

Concerns over currencies are really indicative of an even more serious malaise. Lack of co-operation among countries is a striking feature of the post-crisis period. It is noteworthy that the world's leading economies came together — through the G-20 and other fora — during the peak of the crisis and agreed to take co-ordinated action such as in the timing and duration of the stimulus packages.

Besides, the underlying cause for the currency war is to be traced to the phenomenon of global imbalance, the surplus of some countries, notably China, financing the deficits of deficit countries such as the U.S. Unless this imbalance is unwound in an orderly manner, there would be periodic disputes of one kind or another. Correcting these imbalances, according to some economists, will help create jobs in the U.S. and reduce the threat of inflation and asset bubbles in China. However, unwinding of any sort requires a far higher degree of co-operation than is seen now.

Finance ministers and central bankers from some 187 countries attended the annual IMF-World Bank meeting in Washington recently. The meeting was held on the backdrop of an escalating war over currency rates. The two principal protagonists, the U.S. and China, had hardened their respective stances. The U.S. has armed itself with legislative powers to levy duties on China's exports, should the latter refuse to revalue the yuan. China has its own strong reasons to resist pressures to revalue its currency. It can fall back on historical precedents.

Following the Plaza Accord in 1985, Japan was forced to revalue the yen in relation to the dollar. That was an experience; many economists think that landed its economy in a prolonged period of slump.

The debate over currency valuation dominated the IMF meetings. The U.S. efforts to rope in other countries to help persuade China to revalue the yuan met with limited success. Many saw in this a profound development: the balance of global economic power is surely and steadily shifting away from the U.S and other rich countries to the emerging economies of Asia and Latin America. It will no longer be possible for seven or eight rich countries to decide on global economic matters without having the bigger emerging economies of China, India and Brazil on board.

Solution to dispute

A solution to the currency dispute between the U.S. and China will involve allowing the yuan to rise. That would make China's exports more expensive and American exports cheaper, rebalancing will become easier. China will save less and spend more while the U.S. will do the reverse. The U.S. had tried to bolster its case further by arguing that China would also benefit by letting its currency rise.

Apart from reducing the risk of inflation and asset bubbles, a cheaper yuan would help reorient growth away from exports and coastal manufacturing areas and toward domestic consumer demand and poor rural regions in need of development.

All these are no doubt desirable goals something which China is obviously committed to. However, it is too simplistic to visualise a lasting solution to the currency dispute between the two counties by merely revaluing the yuan. China has deflected criticism by promising a gradual currency moves. It has also pointed out other causes for global imbalance.

Moreover, in exchange related matters, it is futile to pin the blame on any one country. The ultra-cheap monetary policy of the U.S. is flooding emerging markets with enormous liquidity. That has created major macro economic problems for countries including India and Brazil. One consequence has been a weakening dollar against other currencies, something which its major trading partners, Europe and Japan, do not want.

The IMF with its 187 members is not the place where important decisions regarding the global economy can be taken. Changes brought about through the IMF are incremental in nature. Besides, national governments will have to incorporate them in their policies. Therefore, it is not at all surprising that the U.S.-China currency dispute will remain at the centre stage during the mid-November G-20 meeting in Seoul.

The U.S. seems to have lost its clout during the crisis. Some of the biggest Wall Street names contributed to the financial crisis and remained at its epicentre. Another reason why the IMF and other global bodies are not effective is that there is no special mechanism to deal with issues such as the one over currency values.

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