Archive for October, 2010|Monthly archive page

A ‘Currency-Cold War’ in the Making?

In Economics, Financials, Politics on October 3, 2010 at 13:52

Although global economic recovery is underway, it’s also being uneven. On my last post I examined the potential effects of the newly-formed Basel III rules on global recovery and concluded to their minor impact. Today, however, global recovery is facing a new challenge; the prospect of a currency war between two giants.

Back in April 2009 in London, the G-20 agreed on fiscal and monetary cooperation and coordination as well as pledged to “refrain from competitive devaluation”. Now that recovery is evident in most parts of the world, China endeavors to re-stimulate its exports and boost its aggregate growth. The fresh visit of the top Chinese official, Wen Jiabao, in Europe was signaled by his commitment not to reduce China’s European bond holdings, a tactic likely to continue to keep the yuan undervalued.

The US and China have been constantly involved in a ‘war-of-words’ concerning the latter’s exchange rate policy to artificially keep the yuan at low levels and favor its exports. The cheap yuan increases Chinese exports to the US and hurts the competitiveness of US-domestic companies. With US unemployment near 10 percent and growth rates extremely anemic, the US government needs to take drastic measures to contain its trade deficit and improve the competitiveness of its domestic businesses.

Back in June, the People’s Bank of China decided to let their currency float versus the dollar, but since then it has only appreciated by a mere of 2 percent. It was a clever tactic move to gain extra time and ease US outcry with respect to currency manipulation.

Still, US lawmakers are taking their own measures. This past week, they proposed a new currency bill (to be voted after the Nov. elections) that would penalize countries that violated free-trade rules, like currency manipulation. In my view, if this proves to be a pragmatic policy, then a trade war is on its way and there will be no winner as USA and China are two highly-interdependent economies; US-consumers buy bulks of Chinese products and the Chinese government finances the US state by buying large sums of T-bills.

The dollar is under severe global pressure. It seems incapable of absorbing global economic uncertainty. The current state of the domestic American economy cannot back it up and its large trade deficit is a loud testament to its unattractiveness. China has tremendous growth prospects but its huge US bond holdings make it highly-dependent to the USA. China will keep subsidizing its exports until its domestic consumption is active and big enough to be the major driver to sustainable growth.

The rest of the world is like the audience to a drama play. The euro needs to put its home affairs in order first and the other economies simply lack the politico-economic capital to challenge the US or China on that front. Only the Japanese yen can have an active ‘say’ in this friction given its long-suffering from the undervalued yuan. Is this a ‘Currency-Cold War’ in the making? I sure don’t know for sure, but the similarities cannot be ignored; high political tensions, polarized groups, wars-of words, extreme political measures and the fact that the winner, if any, out of this ‘war’ will probably be (or continue to be) the world’s next superpower, all converge to this proposition.

NOTE: next post will probably be on China’s capacity to challenge USA’s politico-economic hegemony(?). Please send us any material or views you may have on this topic on our email in the ‘Contact Us’ section.

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