The run up to the G20 meeting in Seoul in November is raising much talk of currency wars. China is as ever reluctant to let its renminbi rise rapidly against the US dollar. The US and UK are pursuing a policy of quantitative easing which may lead to a fall in their value. The euro totters on the brink of catastrophe. Japan’s central bank has intervened actively to hold down the yen.
Asia seems to offer some interesting grist to the mill of this discussion, in part perhaps because the bulk of the discussions at present concentrate on China’s renminbi as the currency most in need of revaluation (with reports generally repeating the truism that it must increase by 20% to 40% against the US dollar, a figure which seems to have come from a report at the Petersen Institute for International Economics).
But what this debate tends to ignore is that China is not alone in pursuing this policy, which might more actually define Asia as a whole. This is simply not a question of the US vs. China. Titanic Japan (still big despite deflation and China’s growth), and smaller but important economies including South Korea and Taiwan have all taken similar measures to keep their currencies weak in order to protect exports (and maintain the Asian manufacturing models which most economists accept are unsustainable given the collapse of demand in the recipient economies). Even nimble Singapore has relied on this approach in the past. So it’s not fair to blame just China without looking at other strategic allies of the US such as Singapore or Taiwan which play similar games. But they aren't the next superpower, are they?
The next issue relates to the globalisation of finance. China has long maintained a closed capital account, but now other Asian economies, including Thailand, Taiwan, Indonesia and some outside the region such as Brazil, appear to be emulating China by limiting capital flows linked to destabilising hot money through the application of a range of tools. Of course, these tools at present only amount to changes at the margin and a big question mark hangs over the effectiveness of capital controls at any rate. They do, though, seem to amount to an understanding that China has got it right and in the eyes of alarmists suggest a move towards a thoroughgoing rejection of system the free capital flows now associated with financial collapse.
So is the world economy going to fall off a cliff as currency devaluation acts as a means to maintain trading advantages and as countries seek to constrain capital?
The signs might be more positive than the current rhetoric presents.
Perhaps the first point to raise relates to quantitative easing, which may reduce the value of currencies like the USD and GBP but could also result in inflation either in western states (thereby amounting to a cleansing default on debts so reducing the scale of that problem) and/or in the Asian states (or others which control their currencies but not their capital accounts) in the form of higher prices. Both these steps could help the rebalancing, even if they are not painless or victimless (and could lead to other imbalances around the world economy).
In this context, it is interesting and even heartening that some Asian economies are reacting to curb the inflationary threat. Interestingly, the Monetary Authority of Singapore has decided to continue to permit a rise in the value of its controlled currency, as the authorities assessed inflation to be a growing concern. Singapore is a classic canary for the world economy, since its openness means it catches every cold quicker than anyone else (look at its extraordinary downturn and then recovery over the last few years).
China is obviously a case apart because it has a closed capital account, although money is leaking back and forth (in suitcases of cash through Hong Kong and in price rises, as seen in labour in recent months). The measures to tackle bank lending and house prices suggest that asset price rises are something the authorities are taking seriously. A further point to make might be that rebalancing does not have to take place through exchange rates; it can occur through real exchange rate shifts, through the price of labour or other comparable measure. And it is very hard for even countries like China to curtail this without seriously draconian measures.
What happens next then? Several questions come to mind:
- Can the US (maybe 23% of world GDP) resist protectionist measures? My instinct is yes, based perhaps more on hope than knowledge, up to a point, and at any rate why should it subsidise a Chinese potential opponent?
- Will China (maybe 12% of world GDP) permit a revaluation? China still relies heavily on access to the US market, but its policymakers recognises the need to change direction; it may well do so if given the space to climb down without an overt loss of face, subject to constraints of balancing the economy (and thereby preventing an outbreak of chaos long feared by the Communist Party).
- Can the EU (a further 27% or so of world GDP) hold it together? This is a bigger risk, given that Europe is unable to forge a united front to deal with this problem, but is one that Asian countries are generally watching rather than influencing.
- Will Japan (maybe 12% of world GDP) keep the yen down? It's trying to do so, intervening on the yen to protect its sickly economy. It will probably continue to seek to do so, although its close relationship with the US would make such a long term effort unlikely (especially given recent tensions with China which have thrown the troubled lovers back into each other’s arms).
So perhaps the likeliest outcome is an uneasy standoff, defined by spasmodic efforts to cut people out of markets, some grumbling over currency values, followed by prices shifting in certain places suddenly leading us into a brave new world. After all, it takes time for trade frictions to froth up into tensions or even war. They tend to start as niggling issues and build over time.
This hopeful view, though, is contingent on everyone keeping their heads, and on the longer term hope that Asian states (and not just China) can find a new economic model not reliant on massive overproduction of industrial goods. It is not clear what that will be, and it will require rethinking not just in Beijing, but in Taipei, Singapore, Seoul, Kuala Lumpur and a host of other places.