[Do notice the asterisk in the title for I'll have more on it towards the end of the post.] It seems the FT's Martin Wolf is continuing a line of argument that began with his book Fixing Global Finance. In it, he ascribes more blame for the global financial crisis on developing countries which do not necessarily subscribe to the whole neoliberal package including unfettered capital flows and more or less market determination of exchange rates. Is it really a North-South conflict over currency practices? For what it's worth, consider that the Japanese are now chiding South Korea and China over currency intervention in the run-up to the Seoul G20. While this strikes me as a bit rich since the BoJ recently went back into the currency markets after being absent for six long years, their authorities dubiously claim that their action was not really meant to influence the USD/JPY level but to temper excess volatility. Well, whatever.Let's now turn to those Americans who are about to drop tonnes of dollars from the skies via renewed helicopter-dropping [1, 2]. Martin Wolf's new argument is a simple one in the context of Guido Mantega's so-called international currency war: You cannot "defeat" the US in this battle since its ammunition is infinite. A lot of dead trees + the printing press = unlimited dollar emissions to overcome the most determined foe of quantitative easing part two (I'd call it "QE2" if that acronym weren't already taken). And so Wolf goes...
To put it crudely, the US wants to inflate the rest of the world, while the latter is trying to deflate the US. The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world...Wolf ends on kind of a flat note by stating the need for some sort of cooperation to forestall every country for itself kind of behaviour. What remains odd, however, is Wolf's reluctance to criticize America for running the printing press at full tilt. In other words, the most selfish behaviour is that of the US but he refuses to acknowledge it but sees it instead as an inevitability:
In short, US policymakers will do whatever is required to avoid deflation. Indeed, the Fed will keep going until the US is satisfactorily reflated. What that effort does to the rest of the world is not its concern.
The global consequences are evident: the policy will raise prices of long-term assets and encourage capital to flow into countries with less expansionary monetary policies (such as Switzerland) or higher returns (such as emerging economies). This is what is happening. The Washington-based Institute for International Finance forecasts net inflows of capital from abroad into emerging economies of more than $800bn in 2010 and 2011. It also forecasts massive intervention by recipients of this capital, albeit at a falling rate.
Recipients of the capital inflow, be they advanced or emerging countries, face uncomfortable choices: let the exchange rate appreciate, so impairing external competitiveness; intervene in currency markets, so accumulating unwanted dollars, threatening domestic monetary stability and impairing external competitiveness; or curb the capital inflow, via taxes and controls. Historically, governments have chosen combinations of all three. That will be the case this time, too.
Naturally, one could imagine an opposite course. Indeed, China objects to the huge US fiscal deficits and unconventional monetary policies. China is also determined to keep inflation down at home and limit the appreciation of its currency. The implication of this policy is clear: adjustments in real exchange rates should occur via falling US domestic prices. China wants to impose a deflationary adjustment on the US, just as Germany is doing to Greece. This is not going to happen. Nor would it be in China’s interest if it did. As a creditor, it would enjoy an increase in the real value of its claims on the US. But US deflation would threaten a world slump.
Prof Blanchard is clearly right: the adjustments ahead are going to be very difficult; and they have also hardly begun. Instead of co-operation on adjustment of exchange rates and the external account, the US is seeking to impose its will, via the printing press. The US is going to win this war, one way or the other: it will either inflate the rest of the world or force their nominal exchange rates up against the dollar. Unfortunately, the impact will also be higgledy piggledy, with the less protected economies (such as Brazil or South Africa) forced to adjust and others, protected by exchange controls (such as China), able to manage the adjustment better.Way to go America; we really appreciate it ;-) And now we get to the asterisk: I do think China still has a longer-term solution in establishing the use of its own currency as an alternative vehicle currency for international trade. It is already experimenting with dollar swaps with some trading partners to settle trade in RMB. Should these small-scale experiments prove tenable, we may eventually see moves towards a freely traded yuan and, as a consequence, more market determination of its exchange rate:
It would be far better for everybody to seek a co-operative outcome. Maybe the leaders of the group of 20 will even be able to use their “mutual assessment process” to achieve just that. Their November summit in Seoul is the opportunity. Of the need there can be no doubt. Of the will, the doubts are many. In the worst of the crisis, leaders hung together. Now, the Fed is about to hang them all separately.
The funny thing is that Martin Wolf ultimately paints a similar scenario in Fixing Global Finance. On p. 181 according to my library copy, he too envisions the creation of a "yuan bloc" as a linchpin of a regional currency unit:
An alternative is regional pegging on a core currency within a more general float. That is what happened in Europe during the era of the European Monetary System. The Americas have a natural anchor currency in the dollar. In East Asia, however, no dominant currency exists, with the dollar, renminbi, and yen all important. The likelihood is a shift from targeting of the dollar to targeting of the renminbi. That should happen automatically over the next two decades, provided China abolishes exchange controls. A de facto currency area is then likely to emerge in that region, focused on the renminbi. But first the renminbi would need to become more flexible. At present both the yen and renminbi are instead targeted toward the dollar, making the dollar the region’s anchor currency.I hope I live to see the day when we are liberated from the dollar's odoriferous stench of putrefying American decay. When it comes to talk about hanging, there is no doubt in my mind as to who the dead meat is. It's time for China, in tandem with Asian countries, to work themselves free of such economolestation. If that eventuality is hastened, well, perhaps it's worth turning the rest of the world off America even more.
