European policy makers worry that a resurgent euro will threaten growth in their own backyard. And the entire world, it seems, is jawboning China to level the playing field and let its undervalued currency, the renminbi, appreciate. It is a step that Beijing, by all accounts, does not want to take.
With so many economies struggling, it suddenly seems as if it is every nation for itself in the currency markets. Policy makers the world over are worried that economic rivals are trying to turn exchange rates to their advantage, and considering how they should respond to preserve jobs and growth at home.
Even as Washington chides Beijing over the renminbi, critics accuse the United States and other rich nations of waging an international currency war that harks to the protectionist policies of the 1930s, when nations looked out for themselves rather than working together.
“Today, there is a risk that the single chorus that tamed the financial crisis will dissolve into a cacophony of discordant voices, as countries increasingly go it alone,” IMF Manging Director Dominique Strauss-Kahn, said during a speech in Shanghai this week. The abrupt decline in the dollar — by about 10 per cent since early June against major currencies — is upsetting the delicate balance of world economies, still recovering from the shocks of the financial crisis.
Many other currencies, especially in Asia and in emerging markets like Brazil, are soaring as a result of the dollar’s fall. Those nations’ domestic economies are attracting floods of speculative capital seeking higher interest rates and are at risk of overheating. The dollar’s decline is being driven by what everyone in global markets is now expecting: another round of so-called quantitative easing by the United States. In the next few weeks, the Federal Reserve is expected to inject vast sums of money into the economy in another attempt to spur growth.
While such policies may benefit the convalescent the US economy, they are also drawing criticism that Washington is deliberately devaluing the dollar at others’ expense.
The dollar had at least a brief uptick last week, as global investors sought the currency as a haven after China startled the markets by raising interest rates. But its fall resumed to a 15-year low against the yen, and currencies like Brazil’s real — up more than 12 per cent since July against the dollar — were still lofty.
The tensions underline the startling fact that two years after the peak of the financial crisis, the world is on two tracks economically. Much of the developing world, including countries like China and Brazil, is growing fast, while the industrialised economies of the United States, Japan and much of Europe still struggle.
In Brazil, officials have been especially critical of United States policy. On Sept. 27, its finance minister, Guido Mantega, first described the currency tensions as practically an “exchange war, a trade war.” This week, Brazil’s central bank governor said that Washington’s expected monetary stimulus “creates serious distortions.”
In deflecting criticism, the United States emphasises the role of China, an ever-growing power in the global economy. Beijing continues to peg the value of its currency to the dollar, despite an immense accumulation of foreign reserves and a persistent surplus in China’s account equal to about 10.5 per cent of its annual economic output, a surplus that in standard monetary theory would prompt China to allow its currency to rise.
As a consequence of the link to the dollar, the Chinese renminbi has also declined — which is one reason that despite the fall in the dollar, the United States trade deficit has continued to widen.The weakness in the renminbi, just as much as the dollar’s decline, has put pressure on economies across the developing world, where a weaker renminbi undercuts their exports, and hence their growth.
Financial markets expect the Fed to announce at its meeting early next month that it will proceed with more quantitative easing, involving purchases of bonds, which reduces longer-term interest rates and puts further downward pressure on the dollar.
That worries other countries. A stronger United States economy is in everyone’s interest, but they fear that investors will flee America’s low interest rates and declining dollar and instead pour capital into their markets, overheating their economies and creating the types of asset bubbles in stocks and housing that burst with such devastating effects in the 1990s.
Already there is evidence of this: American investment in overseas stock funds, which was running at about $4 billion a month over the summer, has surged since Ben S. Bernanke, the Federal Reserve chairman, suggested the possibility of another round of quantitative easing at the end of August.
In recent weeks, central banks around the globe, including those of the Philippines, Thailand, Indonesia, Malaysia, Israel, Taiwan, Brazil and Japan, have intervened furiously in foreign exchange markets in hopes of weakening their own currencies. But currency speculators, moving just as fast, so far seem to be largely undermining those efforts by selling their dollars and betting that the American currency will continue its decline.
In the Chicago futures markets, one of the principal arenas where traders can take positions against the currency, positions betting on a depreciation of the dollar totaled $32.6 billion in the latest week, close to a record, according to the investment firm Nomura. Some countries have gone further than merely criticising the United States, embracing forms of capital controls to reduce incoming short-term investment. Brazil is increasing the tax on money flooding into its bonds. South Korea cited the need to check speculative foreign capital inflows.
Some economists play down the fears of currency battles and see the dollar’s movements as a natural readjustment to a weaker economic outlook in the US. The dollar suffered periodic bouts of weakness before. It strengthened through 2008 but weakened in 2009. More generally, it has been on a longer-term decline since 2002. Some economists think it could recover again soon.
But others worry that that by letting the dollar weaken, Washington may be stoking dangerous inflationary pressures that will have repercussions around the world. “The United States has an important role in the world economy to maintain stability and confidence in the dollar,” said Stanford economist and former under secretary for international affairs at Treasury John B Taylor.