Litovchenko I.

PhD Zhukova O.S.

PhD Petrachkova O.L.

World currency war

In recent weeks the world economy has been in a war status, at least it looked as so. Ever since Guido Mantega, the Brazil’s finance minister, proclaimed on September 27th that an “international currency war” had broken out, the global economic debate has been recast in area of conflict terms.

Countries blame each other for distorting global demand, with weapons that range from quantitative easing, notably printing money to buy bonds, to currency interference and capital controls.

In fact there are three battles. The biggest one is over China’s disinclination to permit to rise more quickly. Last month a law was passed by the House of Representatives allowing firms to seek tariff protection against countries with undervalued currencies, with a huge bipartisan majority. China’s “unconscientiously” trade practices have become the main topic in the mid-term elections.

The second problem is the rich world’s monetary policy, particularly the prospect that central banks may soon restart printing money to buy government bonds. The dollar has fallen as financial markets expect the Federal Reserve to act fastest and most fearlessly. The euro being officials at the European Central Bank shows least enthusiasm for such a shift. As for China’s opinion, quantitative easing creates a gross distortion in the world economy as investors rush elsewhere, especially into emerging economies, in search of higher yields.

A third area of contention is from how the developing countries respond to these capital flows. Rather than let their exchange rates increase, many governments have intervened to buy foreign currency, or imposed taxes on foreign capital inflows. Recently, for example, Brazil doubled a tax on foreign purchases of its domestic debt. This week Thailand announced a new 15% withholding tax for foreign investors in its bonds.

For now, these fights fall far short of a real currency war. Many of the “weapons” look less threatening on closer examination. The capital-inflow controls are modest. In the rich world only Japan has recently resorted to currency intervention, and so far only once. Nor is there much risk of an imminent descent into trade retaliation. Even in America, tariffs against China are still, but a long way off –both because the currency bill is milder than it sounds and because it has yet to be passed by the Senate or signed by Barack Obama.

Still, there is no room for complacency. Today’s false war could quickly turn into a real fight. The conditions driving the divergence of economic policies – in particular, sluggish growth in the rich world – are likely to last for years. As fiscal austerity kicks in, the appeal of using a cheaper currency as a source of demand will increase, and the pressure on politicians to treat China as a scapegoat will rise. And if the flood of foreign capital intensifies, developing countries may be forced to choose between losing competitiveness, truly draconian capital controls or allowing their economies to overheat.

It is fairly clear what happens. Global demand needs rebalancing, away from indebted rich economies and towards more spending in the emerging world. Structural reforms to boost spending in those surplus economies will help, but their real exchange rates also need to appreciate. And the Chinese yuan is too low. That is hurting not just the West but also other emerging countries, especially those with floating exchange rates. Indeed China needs to get more of its growth from domestic consumption.

It is also clear that this will not be a painless process. China is right to worry about instability if workers in exporting companies lose their jobs. And even reasonable choices – such as the rich world’s mix of fiscal austerity and loose monetary policy – will have an uncomfortable impact on small, open emerging economies, in the form of unwelcome capital inflows. This flood of capital will be less devastating to them than the harm they would suffer if the West descended into deflation and stagnation, but it can still cause problems.

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