As large parts of the world economy remain engulfed in the most serious downturn witnessed since the 1930s, trade and currency rivalries have intensified and even threaten to take the shape of geo-political conflicts. Vineet Kohli, of the Tata Institute of Social Sciences, examines the debate over currency wars.
Much of the western world’s attention is glued to China’s currency, whose undervaluation, it is argued, is adding to their current woes. The argument of deficit countries, like the US, is simple - that by keeping the value of its currency too low, China indirectly cheapens its products and gains unfair advantage in world markets. The undervaluation of its currency allows China to deflect demand from foreign to domestic producers and run large trade surpluses (i.e., the excess of exports over imports).
Leading the ideological charge against China are some well-known figures including Nobel laureate Paul Krugman. Their views have found strong resonance among US congressmen, 130 of whom urged the treasury department in March 2010 to officially identify China as a currency manipulator in its official report. They urged the US administration to mount diplomatic pressure on China to revalue the renminbi and, in the event of the failure of such diplomatic efforts, “to consider all the tools at its disposal, including the application of a tariff on Chinese imports”. The US treasury has delayed the release of its currency report twice – first in April and then again in October. The matter was taken up by the US in the recently concluded G-20 meeting in Seoul but could not find any resolution there. The internal pressure on the US administration to impose import duties on Chinese goods has therefore been growing once again, with a congressional advisory panel recently urging the US treasury to identify China as a currency manipulator.
On the other side of the debate, the Chinese have been blaming the US, partly in response to the latter’s confrontational attitude, for attempting to devalue dollar by following a loose monetary policy. Low interest rates that accompany such loose monetary policy make the US an unattractive destination for financial investments thereby forcing an outflow of such investments from the US to those countries where bond and stock markets offer much higher returns. This is the reason why India along with China, Brazil and some other countries has been facing an upsurge in inflow of foreign investment in their financial markets in recent times. Since the inflow of foreign investment from the US is putting an upward pressure on the currencies of these countries, Germany and China, have pointed out that the US is using cheap money as an intentional policy tool for forcing a revaluation of the currencies of its trade partners. Such a revaluation of their currencies, they allege, will make their goods more expensive in dollar terms and benefit the US producers.
The current experience of growing currency conflicts bears a chilling similarity to the international economic experience during the Great Depression, when most countries responded to economic downturn by stealing demand from others through a reduction in currency values. By their very nature, beggar-thy-neighbour policies like currency devaluations turned out to be a zero sum game. Countries that boosted their trade surplus through currency devaluations and high tariffs also exported their unemployment and recession to their trade partners. Additionally, such policies created an environment of suspicion and hostility between countries that proved detrimental to forging the international co-operation necessary for solving the problem of the global slowdown.
What we are witnessing today in the form of currency wars is the repeat of the mistakes of the thirties. The current bickering over currency values is shifting attention from the more pressing issue of the inadequacy of effective demand. Suppose adequate pressure is made to bear upon China to revalue its currency, it would definitely make Chinese goods more expensive in dollar terms, thereby aiding recovery in China’s trade competitors. But this recovery would come at the expense of effective demand and employment in China. It is precisely this flip side of the renminbi revaluation that is being missed in the current debate. What is required at the moment is a shift towards some form of global Keynesianism whereby world demand is adjusted upwards with the responsibility for this adjustment falling proportionately more on surplus countries. Surplus countries should be assigned a larger role in increasing world demand to ease the pressure of adjustment on deficit countries, many of whom are in the developing world.
It also becomes essential to note at this point that China is not the only country that runs a large trade surplus. Germany’s trade surplus is almost as large as that of China. Japan’s trade surplus, although much smaller compared to that of Germany and China, is also quite substantial. It is insincere to demand a more balanced position from China while maintaining silence on the surpluses of Germany and Japan. All surplus countries should be goaded to move towards a more balanced position through upward adjustment of domestic demand.
Moreover, China has played a much greater role in infusing demand in the world economy after the crisis than is currently being understood or appreciated. China’s trade surplus in the first 10 months of 2010 was 148.5 bn dollars, about 150 bn dollars less than its trade surplus in the corresponding period of 2008. Over the same period, Germany’s trade surplus fell by only 31 bn euros, or at the current market exchange rate, by about 40 bn dollars. Japan should be embarrassed about its contribution, as its trade surplus increased by nearly 40 bn dollars in this period. In other words, Japan sucked in demand from the rest of the world when it should have been doing just the opposite.
China has been able to shed its trade surplus faster than other countries because of its massive fiscal stimulus package. Isabel Ortiz has compared the size of fiscal stimulus packages announced by various countries in the wake of the crisis. Her comparison shows that the stimulus package in China is much larger than in any other surplus country. The size of stimulus package in China was 586 bn dollars, compared to Germany’s 103.3 bn dollars and Japan’s 110 bn dollars.
The performance of the US in this regard also leaves much to be desired. Officially, the US stimulus package of 787 bn dollars announced in the wake of the crisis is the largest in the world. However, a very large share of this stimulus was neutralized because state and local governments in the US, who faced a decline in their tax revenues due to the crisis, are required by their constitutions or charters to run balanced budgets. According to a calculation done by Dean Baker and Rivka Deutsch, after netting out tax increases and spending cuts at the state and local level, the size of the US stimulus falls to 126 billion dollars per year for 2009 and 2010. Effectively, therefore, the American stimulus package is less than half the size of its Chinese counterpart. With an effective stimulus as lame as this one, one wonders whether the US has anyone but itself to blame for its current woes. Much of the increase in the US government debt witnessed after the crisis was not on account of higher government expenditure to support output and employment in the economy but due to bailout sums provided to large banks. The US’ inability to recover from the crisis cannot be directly attributed to China’s insistence on running large trade surpluses, which in any case have fallen quite sharply in the last two years.
Having abjured the fiscal route to recovery that would have involved direct creation of jobs through government expenditure, the US was left with no option but to flood its financial system with cheap money in the hope that it would aid recovery from the crisis. The resultant large flows of finance towards countries that offer higher financial rates of returns is now creating new risks to recovery in these economies. On the one hand, such flows are putting an upward pressure on their currencies thereby hurting their net exports and draining demand out of them and on the other hand, creating bubbles in their asset markets thereby exposing them to the risk of financial crisis. The loss in net exports may have serious consequences for economies like India where external trade accounts are already showing large deficits. These volatile flows of capital have created yet another fault line between countries. The victims of large inflows of capital have various tools at their disposal to control such flows, yet their energies appear misdirected towards monetary easing in the US, which is surely one, although not a foolproof, way of boosting demand and employment in the US and elsewhere in the world. It is the unwillingness of governments to put curbs on cross-border financial flows rather than monetary easing in the US that lies at the root of the problem.
To conclude this discussion, therefore, the most serious impediment to the global recovery is not the value of the renminbi at all but the shortage of effective demand at the world level. In this regard, the contribution of China with its very different political and economic system needs to be appreciated even as it has to be urged to do more. At the same time, countries like Germany and Japan have to be urged to increase their own domestic spending. The US also needs to do more than the measly fiscal stimulus it has provided to its economy so far. This may not be easy since it will require these major capitalist countries to abandon the very model of neoliberalism that requires the state to stay away especially from the areas of demand and employment generation – something that appears difficult unless a major change happens in the configuration of political forces in these countries.
It is precisely for this reason that the current bickering over the currency values is likely to continue in the near future. While not helping the world economy in any substantial terms, it will no doubt vitiate international atmosphere greatly. After all, there are no international rules that prohibit countries from fixing exchange rates at a certain level, the US’ confrontational attitude towards China on this issue will amount to violation of the latter's sovereign policy space. Just as China cannot force the US and Europe to adopt more expansionary policies, the US also cannot force China to revalue its currency. The focus on the value of renminbi will not help matters much. It may, however, make them worse by intensifying trade and political conflicts between China and the US and completely scuttling any hope of the revival of global demand through international co-operation.