NOT ALL QUIET ON THE CURRENCY FRONT / THE FINANCIAL TIMES COMMENT EDITORIAL ( A MUST READ )

Not all quiet on the currency front

Published: October 6 2010 22:33

The scent of war is in the air. Currency war, to be sure, but the consequences for the global economy could still be dire. After a series of interventions aimed at holding down the value of domestic currencies, policymakers have expressed fears of a dangerous race to the bottom in exchange rate policy. The threat should not be taken lightly.


A currency war – contrary to what Guido Mantega, Brazil’s finance minister, said last week – has not yet broken out. Interventions by Japan, South Korea, Switzerland and Taiwan over the past year have been small and intermittent. But the chances of further action should not be played down.


It is not surprising that countries try to boost their exports in a fragile economic environment. Shifting the burden of growth on to foreign consumers is easier, politically and economically, than stimulating domestic demand. But although managing exchange rates is an easy way of giving domestic exporters an edge, it is self-defeating from a global perspective. Everyone cannot export their way out of trouble at the same time.


The prospect of another round of quantitative easing in Britain and the US – which would put downward pressure on their currencies – has heightened tensions. The resulting flow of excess liquidity towards emerging markets also puts pressure on these countries’ real exchange rates, encouraging them to engineer depreciations of their own. A self-perpetuating round of beggar-thy-neighbour currency interventions is not inconceivable.


If this happens, the blame will in no small part be China’s. As its foreign exchange reserves of almost $2,500bn attest, Beijing intervenes on a far greater scale than any other country. As the world’s largest exporter of manufactures, its actions have a big impact on global trade patterns. It has only allowed the renminbi to appreciate minimally against the dollar this year. That means that when the dollar weakens, third countries become less competitive relative to China.


Rebalancing the global economy, of course, will require more than a freer float of the renminbi. China’s trade surpluses are just as much a product of the country’s low wages and high savings. Until these are addressed, and Chinese domestic demand consequently picks up, large imbalances will remain.


Exchange rates are only a partial solution to the world’s economic woes. Even so, the phoney war in currency markets had better not become a real conflict.

Copyright The Financial Times Limited 2010.