The U.S. House of Representatives has with a 348-to-79 majority passed 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 U.S.’ 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 RMB 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 U.S. bill and of the pressure being mounted by the G20 on China to ensure further appreciation of the yuan. 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.

Moreover, central banks from many other countries have been and are intervening in currency markets to hold down the value of their currencies. 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 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 implication is clear. Countries pursuing neo-liberal policies are unwilling to impose controls on capital inflows, encouraging a capital surge and inviting 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.

It must be said that Brazil did try and regulate capital flows with a transactions tax. But obviously that measure was inadequate. So it too has joined the “currency war” blame game, much to the satisfaction of countries which do not want to do even as much as Brazil has attempted in order to curb capital inflows.


G20 reach deal on IMF reform, currency warOctober 23, 2010