World financial leaders agree on the problem. They just don’t have a ready solution to the risk that the global economic recovery will be undermined by nationalistic elbowing over exchange rates.
That’s the message from a statement issued over the weekend by the board of governors of the International Monetary Fund after the IMF’s annual meeting in Washington.
“Economic recovery is proceeding, but remains fragile and uneven,” the communique said. The group officially rejected “protectionism in all its forms,” but also cited “tensions” over exchange-rate movements and imbalanced trade patterns.
The statement called on the IMF to seek answers to this problem.
At the core of the challenge is the difficult relationship between the US and China. The two nations have committed to close and growing economic ties over the past two decades, but also have a long-running disputes over trade and currency policy.
The persistently weak job market this year in America has aggravated the problem. Congress and the Obama administration are pushing China to allow its yuan to float higher, which should give a boost to US exports and make imports from China less attractive to US consumers.
Congressional move to penalize China
The House of Representatives even approved a bill last week that designed to penalize Chinese imports with countervailing duties (designed to offset the alleged currency-rate subsidy).
Beijing officials reacted strongly to the effort to change China’s carefully managed exchange rate. Prime Minister Wen Jiabao said Wednesday that “if the yuan is not stable, it will bring disaster to China and the world.”
Although that’s the highest-profile dispute, policymakers worry about the threat of a broader currency war, in which nations compete to devalue their currencies or hold them at a relatively low level in a bid to promote exports and add jobs at home.
The problem is, it doesn’t work if everyone tries such a policy at once. “All sorts of efforts are either being announced or contemplated to resist currency appreciation from India to Korea to Taiwan and now Brazil,” economist David Rosenberg of the Toronto investment firm Gluskin Sheff wrote earlier this week.
Money has been flowing into emerging-market nations, helping to put upward pressure on their currencies, because their economies have been stronger than the US or Europe.
One risk is that beggar-thy-neighbor currency policies will be coupled with an escalation of tariffs and other protectionist measures – all of which could put a squeeze on world trade and growth.
Nations that try to avoid the fray can be punished as well.
This week the euro soared relative to the US dollar, in part on expectations of a more expansionary (inflationary) monetary policy from the US Federal Reserve. The strengthening euro, while in one sense a vote of market confidence, could harm European exports during an already weak economic recovery.
Trade imbalance needs correcting
Many economists agree that the pattern of imbalanced trade – with the US importing much more than it exports while nations like China seek to fuel their growth through exports – needs to be corrected.
Some policy experts argue that now is the time for the US and others to push that question, through pressure on China.
“For the recovery to be sustainable there must also be a change in the pattern of global growth,” US Treasury Secretary Tim Geithner said in a statement at the IMF meeting Saturday. “It is critical to see more progress by the major emerging economies to more flexible, more market-oriented exchange rate management.”
The get-tough approach has critics as well as supporters.
Stephen Roach, an economist who represents Morgan Stanley in the investment firm’s Asian operations, warns that moves such as the currency legislation passed by the House could backfire.
“At best, it is a circuitous solution that would address only one of the many pressures shaping the imbalances,” he said in a written comment last week. “At worst, it would lead to a trade war, or risk jeopardizing China’s understandable focus on financial and economic stability.”
All this leaves a delicate task ahead for global finance ministers and the IMF. In the group’s new outlook report on the world economy, though, it warned that rebalancing the world economy is a matter of necessity. That’s because consumers in the US can’t afford as many imports as they could before the financial crisis.