Fumbling towards a truce
The first of three pieces on currency tensions looks at a possible path to peace
Oct 14th 2010 | WASHINGTON, DC
THE organisers of this year’s annual meetings of the International Monetary Fund and World Bank, held in Washington, DC, on October 8th–10th, wanted to jazz up what can often be tedious gatherings. There were fewer turgid official speeches, more snazzy seminars and even an outdoor café for visiting nobs to chat in the unseasonably warm weather. Unfortunately, despite the sunshine and swish surroundings, the meetings were depressing, dominated by dark talk of global currency wars.
Policymakers traded barbs about whose actions harmed the world economy most. Rich countries, especially America, focused on China’s unwillingness to allow the yuan to rise (see article). Tim Geithner, the treasury secretary, set the tone with a tough admonition just before the gathering began. China’s unwillingness to allow the yuan to rise, he said, created a “dangerous dynamic” of “competitive non-appreciation” in emerging economies. Excess accumulation of reserves, he added later, was leading to “serious distortions” in the world economy.
Nonsense, responded China’s officials. The biggest distortion, they argued, came from the rich world’s ultra-loose policies, particularly the expectation that America’s Federal Reserve would soon reactivate a policy of “quantitative easing” (printing money to buy government bonds). Such massive liquidity creation, said Zhou Xiaochuan, the governor of China’s central bank, would swamp emerging economies with destabilising capital inflows.
Officials from other emerging economies also fretted about the consequences of the rich world’s policy choices. Several argued against rapid fiscal contraction, since loose fiscal policy had fewer knock-on effects than loose monetary policy. Stanley Fischer, the governor of Israel’s central bank, wondered why emerging markets that didn’t have financial crises should accept currency appreciation forced on them by strong capital inflows as the rich world cleaned up its own mess.
More academic types railed against the madness of an international monetary system in which global imbalances are set to widen again and the pace of reserve accumulation is accelerating. Figures released on October 13th showed that China’s reserves reached $2.6 trillion at the end of September. By the end of 2011 the IMF expects China’s stash to exceed $3 trillion, and that of emerging economies as a whole to be almost $6.8 trillion, more than 50% higher than before the financial crisis (see chart). Pessimistic types painted a dark future of trade wars and capital controls. South Korean officials were especially glum, worried that the ongoing currency row was going to overshadow the Seoul summit of the G20 on November 11th.
Look carefully, though, and much of today’s gloom is as overdone as the military metaphors that now pepper the currency debate. The world is a long way from open conflict. Even in America, where anti-China politics are most poisonous, trade retaliation is some way off. So far both the scale of capital inflows to emerging economies and the actions taken to counter them are hardly out of the ordinary. Chile was trying to deter short-term capital inflows in the early 1990s, for example.
The furore about currency wars has confounded several separate policy issues. One is the scale of rebalancing that the world economy requires, and the role of exchange rates in that process. A second issue concerns the spillovers from policy choices, both within the rich world and between rich and emerging economies. A third set of questions asks how emerging economies, especially small open ones, should best distinguish between a permanent rise in capital inflows and a temporary surge—and how they should deal with such a surge.
Managing currency tensions will require greater harmony on all these fronts. Fortunately, for all the rhetorical barbs, there are some signs of progress. In a little-noticed comment during the weekend’s meetings, Yi Gang, a deputy governor of China’s central bank and head of the country’s foreign-exchange reserves, said that China aimed to bring its current-account surplus below 4% of GDP within 3-5 years. In the hope of shifting the conversation away from currencies, South Korean officials have been pushing the idea that G20 leaders embrace goals for current-account surpluses and deficits at the Seoul summit.
Explicit current-account targets have their shortcomings, not least that policymakers can influence them only indirectly. Germany, which runs a bigger surplus than China, is deeply opposed. But broad agreement on the scale of global rebalancing required would be useful. So, too, would a more systematic analysis of the exchange-rate adjustments needed to get there, as well as an assessment of the spillovers between countries’ policies. Quantitative easing, for instance, need not work only, or even mainly, through the exchange rate: early in the Fed’s first bout of quantitative easing, the dollar rose. The IMF’s boffins have been charged with providing just such analysis.
These innovations may sound small-bore amid the drumbeat of war. But they offer a route to multilateral management of the tensions. The process will not be simple. The G20 summit in Seoul will not produce a comprehensive global agreement along the lines of the 1985 Plaza Accord. But if cool heads prevail, peacemaking metaphors could yet become as pervasive as today’s bellicose ones.