Currency Tensions Rising

The fact that an IMF meeting ended with the participants unable to feign a narrowing of differences on the currency front is further evidence that positions are hardening. And let us put none too fine a point on this: the currency row is simply an acceptable way to fight over imbalanced trade patterns.

As we pointed out in a 2007 post, “The Dangers of Overselling, and Overdoing, Global Trade“:

Dani Rodrik…makes the point that globalization fans may be their own worst enemy by taking the simpleminded point of view that if globalization is good, more globalization is of course better. Rodrik reminds us that globalization needs to be balanced against national interests, and some of the nations touted as big beneficiaries of more open trade markets, such as India and China, in fact did not open their markets to imports until their growth rates were increasing handily.

His most important observation is “If there is one lesson from the collapse of the 19th century version of globalisation, it is that we cannot leave national governments powerless to respond to their citizens.” Yet some of the proponents believe in the sovereignity of markets, that any attempt to intervene in markets will only yield bad outcomes, and will in any event be futile because the forbidden activity take place despite the barriers we try to erect (hhm, if we really believed that, we wouldn’t be using economic sanctions against Iran, now would we?).

It’s similar to an argument made by William Greider in a New York Times article, “The Truth Deficit,” in which he makes the case that the system we operate under isn’t free trade, it’s managed trade, and most other countries play the game in a way to produce better national outcomes (fewer lost jobs and trade surpluses). We seem to be running our trade policy not to optimize our national interest, but that of large international corporations, which is far from the same thing.

Yves here. The threat to a system with a high level of international trade is the existence of large players who run persistent surpluses. That requires that someone, perhaps lots of someones, are in the position of running large trade deficits, which also entail rising domestic debt levels. When the debtor nation gets tired of playing this role (which can come about for a host of reasons), its new found religion forces adjustments on its trade partners.

For the US, reducing our trade deficit really means reducing imports of manufactured goods. That ultimately also means increasing exports, but that will take a longer time to put into effect, assuming the US multinational vogue for offshoring can be partially reversed. Before readers start haring on how cheap labor is in Bangladesh, recall that factory labor is only 10% of the final sales cost of most manufactured goods, and sending work overseas involves some offsets (transit time, which reduces flexibility, higher managerial/coordination costs, need to finance a longer production cycle). So in many industries, more flexible, just in time manufacturing could have been competitive in quite a few sectors. The real reason for the loss of jobs isn’t so much worker cost as lack of management imagination and resourcefulness (how fashionable is it in the US these days to be in a manufacturing business? “Talent” wants to be on Wall Street or in Silicon Valley).

Bloomberg presented the battle lines:

Exchange rates dominated the IMF’s annual meeting in Washington on concern that officials are relying on cheaper currencies to aid growth, risking retaliatory devaluations and trade barriers. China was accused of undervaluing the yuan, while low interest rates in the U.S. and other rich nations were blamed for flooding emerging markets with capital…..

At the same time, officials from emerging economies including China complained that low interest rates in the U.S. and its developed-world counterparts mean investors are pouring capital into their markets, threatening growth by forcing up currencies and inflating asset bubbles.

The Financial Times gives an even uglier assessment:

Global economic co-operation was in disarray and further battles in the currency war looked likely after the weekend’s international meetings of finance ministers and central bankers broke up with no resolution.

The world’s largest economies remained as far apart as ever on currencies. China accused the US of destabilising emerging economies by allowing ultra-loose monetary policy to flood the emerging world with money, while the US insisted the International Monetary Fund should intensify its focus on exchange rates and the reserve accumulation of China.

The lack of any substantive agreements and brinkmanship on proposed reforms to the IMF is likely to exacerbate currency volatility in the month running up to the Seoul Group of 20 summit.

Some Fed defenders may contend that its super lax strategy is simply because the central bank is trying to forestall deflation with the only tool it has at hand. By contrast, Ambrose Evans-Pritchard argues that the Fed’s QE2 strategy is aimed at countries that are suppressing the value of their currencies:

Asian investment in plant has run ahead of Western ability to consume. The debt-strapped households of Middle America, or Britain and Spain, can no longer hold up the dysfunctional edifice. Asians must take over, or it will come down on their own heads.

The countries actively intervening in exchange markets to suppress their currencies – China, Japan, Korea, Thailand, even Switzerland, to name a few – are all too often the same ones that have the biggest trade surpluses with the US.

They are taking active steps to prevent America extricating itself from the worst unemployment since the Great Depression, now 17.1pc on the latest U6 index and rising again.

Each country is doing so for understandable reasons: Japan to avoid a deflationary crisis, China to hold together a political order that is more fragile than it looks. In both these cases they are trapped because they clung too long to a mercantilist export strategy, failing to wean themselves off American demand when the going was good.

Yet this is an intolerable situation for the US. It should be no surprise that Washington has begun to retaliate in earnest, and not just by passing the Reform for Fair Trade Act in the House (not yet the Senate), clearing the way for punitive tariffs against currency manipulators.

The atomic bomb, of course, is quantitative easing by the Federal Reserve. America has in effect issued an ultimatum to China and G20: either you stop this predatory behaviour and agree to some formula for global rebalancing, or we will deploy QE2 `a l’outrance’ to flood your economies with excess liquidity. We will cause you to overheat and drive up your wage costs. We will impose a de facto currency revaluation by more brutal and disruptive means, and there is little you can do to stop it. Pick your poison….

Devaluation was not the mistake of the 1930s: it was the cure, albeit a bad one. The Gold Standard broke down during the inter-war years because the US and France had structurally undervalued exchange rates (like China/Asia today) and ceased recycling their trade surpluses (like China/Asia today). This caused a deflationary downward spiral for everybody.

Escaping from such a deformed system was a path to recovery. The parallel with modern globalization – though not exact – is obvious. So is the 1930s lesson that currency and trade clashes are asymmetric: they are calamitous for surplus countries, but not always for deficit countries. Britain enjoyed a five-year mini-boom after retreating into an Empire trade bloc in 1932.

As much as China backers are loath to hear it, big creditor nations (the ones in the position of China) suffer worse in the wake of financial crises than debtor countries. That hasn’t happened so far because China has dumped a ton of liquidity in its economy to drive domestic investment to unheard-of levels, nearly 50% of GDP. In addition, it has kept the renminbi pegged to the falling dollar, enabling it to maintain its trade surplus at the expense of other exporters, notably Japan. It’s been able to delay a day of reckoning, but the end game is approaching.

Update 8:00 AM: This Tim Duy post is an important addition, please be sure to read it in its entirety. The summary:

Bottom Line: The time may finally be at hand when the imbalances created by Bretton Woods 2 now tear the system asunder. The collapse is coming via an unexpected channel; rather than originating from abroad, the shock that sets it in motion comes from the inside, a blast of stimulus from the US Federal Reserve. And at the moment, the collapse looks likely to turn disorderly quickly. If the Federal Reserve is committed to quantitative easing, there is no way for the rest of the world to stop to flow of dollars that is already emanating from the US. Yet much of the world does not want to accept the inevitable, and there appears to be no agreement on what comes next. Call me pessimistic, but right now I don’t see how this situation gets anything but more ugly

Print Friendly, PDF & Email


  1. Monko

    It should also be made clear that the reason why international big business is a big supporter/lobbist for “free trade” is because it removes the transaction costs (duties/taxes) involved in arbitraging tax regimes, esp. transfer pricing mechanisms.

  2. procopius

    Well, in the absence of the Gold Standard, devaluation is not so simple today. I wish Yves would devote a column to explaining how QE2 would accomplish it. I’ve been trying to wrap my head around what is going on here, and I’m darned if I can figure out how QE2 is going to have any large effect, since the FOMC seems too frightened of inflation to deal with the quantities of dollars that would be needed,

    1. Joel

      I think the immediate effect of QE II will be to increase the price of imported goods in an effort to reduce US consumption of imported goods.

      That is the only means the US has to reduce its deficit since the US is not capable of increasing exports significantly.

      I can’t see any near term impact on US unemployment. The US has no ability to provide cheaper substitutes. The US consumer will just have to pay more for imported goods and reduce consumption as the increased cost becomes burdensome.

      1. Don'tlike what I see

        US can’t increase export significantly, the competition is too high in growing market (Asia, Europe) Eastern europe is destroyed, while US has no access to Africa.

        I think QEII will kill US economy, jsut like Bush did kill US economy with 2007 injection. He tried in inflate carry trade, but ended up inflating food and commodity price, including oil and crashing the already weak consumer.

        Obama QEII will increase unemployment and further destroy manufacturing because price of commodity will increase much faster killing demand of everything. Already gas price increased 8c. (Look at cotton, corn, wheat, local McDonald. Best indicator is milk, egg and fresh vegetable, because they are short lived and transportation intensive.

        The inflation is already killing small folks. And soon will kill all retiree from imploding fixed income yield.

        The excess cash that banks currently hold? That will be used for massive amount of speculation.

        Everything that can go wrong will go wrong.

  3. Cape Gooner

    As has been pointed out by, amongst others, Hudson, if a currency is allowed to float then trade fades into insignificance when compared to financial flows, most of which are speculative.

    The US pressured Japan into floating the Yen – look how well that worked out!

    China will stick to its guns and not allow its currency to become a target for speculators.

  4. Richard Kline

    Bloomberg: “China was accused of undervaluing the yuan, while low interest rates in the U.S. and other rich nations were blamed for flooding emerging markets with capital.” Well, these are two diametrically opposed perspectives, and to be sure both of them could be true. (Both of them _are_ true, in my view.) How, then, is the narrative ‘China, predator’ the one that becomes dominant? I would argue that 0% rates, to say nothing of neg real rates in a QE scenario, are a far greater distorting factor in global trade flows. That conclusion gets no traction in The Land Between the Oceans insofar as I can tell because *cough* said free money is advantageous to our economy whereas the other side of the narrative isn’t. Therefore it must be the predation of those others that’s the imbalance.

    Or not. And I’ll note here how the narrative from the powers that be keeps shifting on this QE proposition. We got 0% policy rates to save the Big Banks, neither more nor less. There was nothing in evidence that when we crashdived the Apparatus to 0 Ben and Paul were thinking about how this affected the cost of tea in China. Then it became, “We’ll have 0% rates to stimulate growth,” an utter canard. We’ve been hearing lately that “We’ll keep 0% rates to stave off deflation.” Now we see a trial balloon from Ambrose the Little Islander that “We’ll go to neg rates to punish the piratical Chinee.” While all along those 0% rates are there to put lipstick on the dead zombie banks. Not even ‘to save the financial system,’ since low or neg rates are devastating to _the rest of the US banking system_ which can’t make any money at ultra low rates. Not that those ultra low rates helps the domestic economy since capital’s getting such a lousy return no one will lend at those rates, so 0% has induced a coma in the real economy. Not that those zero or neg rates will help the consumer, whose debt levels haven’t changed, and so their demand levels remain crushed. We need low rates _and debt write-offs_ as has been often discussed here, but we’re getting zero to neg rates, not to punish the Chinee but to save, nay reward the colossal speculators who’ve shat in the punchbowl. To me, _that_ is the narrative, and a narrative much closer to the Chinese version of things. (Of course, there are numerous other issues involved in Chinese rate policy, some of which reflect badly upon the policy makers there, some of which have ‘Made in America’ stenciled on them too.)

    Regarding nations with trade deficits running up debts, it isn’t always an imbalance: sometimes it’s called ‘a tax.’ As in, We’re an Empire, and we make our own reality. If you have a problem with that, it’s your problem.’ Spain, as an instance created massive inflation in Europe—really destroying the late medieval economy—but importing vast quantities of specie. Because Spain didn’t produce much except soldiers and had huge debts but could manufacture lots of cheap money. Of course to run things day to day Spain had to borrow lots of money since specie only came once a year (and sometimes not at all). When the debt became a problem, Spain simply repudiated it. This ultimately ruined Spain’s creditors (largely in Italy, and particularly in Genoa.) But this didn’t ruin Spain’s _suppliers_. Because they got the money before they gave over the goods, and got the productive development they sought.

    I’m not saying this to imply a perfect parallel, but there’s more to this picture than seems included in the trending narratives. Here’s something on my mind: it’s patent that the US can’t reduce Chinese imports. Why? That’s the death knell on what remains of domestic US demand. We might get supply substitution over a number of years from the Bangladesh’s of the world, but the air pocket of absent deliveries in US retail in the interim would plaster the Big D onto the narrative of the Great Recession we presently hear. Cutting off our head to spite their face so to speak. For the Chinese, having the value of their $ denominated debt plunge is a political problem more than an economic problem (given the rip-offs &etc. China experienced 1800-1950 from the RTW.) In an actual trade war, China does have domestic demand to fall back on. The US does not. The major casualty of a trade war is not China but the global economy, I would say. This is why we have the US thrusting Japan forward as cannon fodder on this issue, both in its currency rate and fustications in China’s near-shore waters. Going reeealll well for the US so far, it would seem. . . . I’ll bet a dollar to a dime that China would land on its feet in any trade war while the US lands on its prat, because that’s exactly what we’ve seen for the last ten years and counting, current on 11 Oct 10. But the US can’t afford a trade war, so we’ll only get one by accident.

    1. Maju

      A couple of details:

      Spain (or the Habsburg Empire, or more technically Castile, which was the only realm in it that actually exercised the colonial empire in America) did not import species as much as silver in huge amounts. In a time when gold and silver meant money, this was like a bank note printing machine gone crazy. The species import element would only apply to Portugal, which was only briefly part of the Habsburg Empire (under Philip II).

      Spain did suffer a lot from the mismanagement of this wealth and power. You only have to read the classics of Spanish literature to see how they whine on how prices went up locally but the silver ended in Genoa and other banking locations. The rather quick decay of Spain as imperial power is directly tied to that thoughtless imperialist mismanagement, which created huge corruption and, by means of the authoritarian ideology of the counter-reformation, an intellectual and economical wasteland. Spain could have done a lot better with all those resources if they would not have been wasted in mindless megalomaniac imperialist projects and instead more wisely invested in long term development, both of the intellectual (specially scientific) and the purely economic kind.

      The Spanish empire lasted about a century and then poof! Soon more reflexive and careful powers (England, Netherlands, France) were replacing it and even, some time later, splitting and/or plundering it at will.

      Instead the British Empire looks like had a more careful, better pondered decay, where the welfare of the nationals (and the nation as a whole) is a central concern. Of course all empires must fall but there is a big difference between doing it the Spanish or the British way, IMO.

      1. MyLessThanPrimeBeef

        I think Spain took some of that silver and bought quite a few galleon-loads/caravel-loads of exquisite Ming porcelain, probably exporting inflation to the Central Kingdom at the same time.

        I am not sure if Spain could have changed any history by investing in science. She might had she been more frugal. A frugal empire is one hard to bring down.

  5. brazza

    AE-P goes on to conclude: “This is a dangerous moment for the world, and may backfire against the US itself. We are already starting to see the same sort of rush into oil and resources that played such havoc in mid-2008, and may have been a key trigger for the Great Recession. There is a risk that this commodity shock will hit before QE stimulus filters through. … The US risks gambling away the “exorbitant privilege” it has enjoyed for two thirds of a century as currency hegemon.”

    Its about to rain money on the banks once again, with no attempt at targeting stimulus to infrastructure development and projects with a direct impact on employment. And odds are even that it will only succeed in accelerating the pace of asset value destruction and probably deepen it. But … it WILL ensure that there is no decoupling – that nobody escapes the down vortex! Mutually assured destruction, or “playing chicken” like adolescent street-gangs, basically. As a policy, it seems to me only marginally less demented that North Korea’s threats to blow itself up if it isn’t fed …

    I had higher aspirations for democratic capitalism – the only system I’ve ever known. But where is the leadership it is supposed to foster so much better than all others?

  6. fjf


    Agreed. And QE2 simply arms the speculators with more cheap dollars.

    To reduce the issues to the most elemental we can observe that there are countries that have concentrated on wealth creation via production. Then there is one entity that has declared “greed is good” and has focused on consumption. This effort ran into problems 10 years ago; the response was to further juice consumption with cheap credit. Now we find that mindless consumption based on cheap credit results in a set of intractable problems not least of which is “How does a second round of even cheaper credit resolve the problems inherent in this approach?” and “How does the attempt to restart consumption via more cheap credit address the need to re-balance the economy with a greater focus on production vs consumption?”

    It should be noted that military endeavors are a form of state consumption; creating products intended to destroy themselves provokes endless demand.

  7. Maju

    Yves: thanks for a most thoughtful analysis (and great links too).

    We are (the World is) today at a very complex crossroads and I see nowhere the statesmen or even thoughtful managers that might straighten this up. It all left to the bankers whose interest is by no means the same as the public, in the USA, in EU or in the World in general. Their only concern is to stay for as long as possible as “masters of the universe”, and what happens to the bulk of the people, and even whole nations like the USA, is only very secondary for them.

    As you say the current ultra-globalized neoliberal market is untenable. But there is no light at the end of the tunnel, whatever the Fed, the G7/G20 or the IMF do is most likely going to be a case of “too little, too late”.

    I am already in a mental state of expecting a total, ugly, dirty and very nasty collapse of the Global Capitalist system. And I am expecting it to happen soon, possibly 2010-11 will set a very bad, unsustainable, scenario but I don’t expect major changes, revolutions or whatever, before the end of the decade – because the sociology is not yet ready for such radical changes, no matter how much needed they are. There is no political leadership anywhere, saying: this ship needs a captain who can hold the rudder firm and I am (or we are) that one. We only see shy bureaucrats and eccentric populists without a proper plan and mostly sold off to the robber barons of banking.

  8. Siggy

    The center of the rising currency tensions is the US Dollar. It’s a fiat currency and for reasons attributable to the reletive size of the US economy, it has become a global reserve currency.

    The emergence of this global problem is founded in the state of the gloabl economy at the end of WWII. US, a creditor nation had the manufacturing and agricultural capacity to supply the world. To avoid another global conflict the US embarks on a plan to reconstitute the manufacturing capacity of Europe most notably in an effort to contain Soviet ambitions.

    Domestically we had easy credit and the unsatisfied demand that was created during WWII. We exported our inflation and Charlie DeGaulle said gimme your gold, not your dollars and finally Nixon said nope, no more Bretton Woods. And then with reconstituted manufacturing in place comes the great labor cost arbitrage and that great sucking sound as US Manufacturing jobs head abroad to places like Japan and Taiwan and the like.

    Now curious thing about inflation, it’s not just a price increase, it’s a loss of purchasing power. And soon, one household income is not enough and the middle class now requires two.

    Now the world is confronted with a fiat reserve currency which is being enhanced by QE??, pick an iteration all in the name of preventing deflation. The propaganda is Orwellian and we have MMT that dances around the concept of stable purchasing power to achive a rationale that says it’s OK to inflate the currency if you are a sovereign.

    My My, who will buy that little piece of shit? Unfortunately, we get to live thru that nonsense.

  9. john c. halasz


    I think this is slightly off, Yves. In recent history, (the last 30 years or so), the elasticity of exports to the value of the U.S.$ has been much greater than that of imports, or, in other words, as the value of the $ depreciates, exports correspondingly rise, but imports, whether in price or quantity terms, remain high. (Of course, there are lots of complications here. U.S. exports might mean high-end capital goods, and there’s some question of the ability or willingness of RoW to absorb further investment in such goods. And, of course, the oil component of the trade deficit rises with the depreciating $ almost automatically.)

    1. Mary

      Elasticity of US export are

      a) car
      b) consumer electronic/computer
      c) telco
      d) service

      a through c are now in asia. This is why Intel income exploded but Dell/HP going nowhere, while Acer, tsmc, lenovo are exploding. Same with Telco. ATT/moto is going nowhere while HTC and all chinese telco are growing exponentially and hitting record ever month.

      Industrial capital goods are flat, just like everybody else.

  10. Eric

    Question for Yves:
    I have the impression that there a number of hedge funds have bet on RMB appreciation. I wonder if any of these funds are pressuring DC to turn up the rhetoric on China…

Comments are closed.