TIME TO END THE MYTH OF CURRENCY WARS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

Time to end the myth of currency wars

By Jim O’Neill

Published: November 21 2010 20:25

In recent weeks, the phrase “currency war” has been used liberally. Let us hope this is a passing fad: it is inappropriate, and actually a fiction. In truth there are no real currency wars, just normal currency markets responding to events.


Let us review the facts. The Chinese currency has risen by about 20 per cent against the US dollar in the past five years. About a tenth of this appreciation has happened since this summer. On a trade-weighted basis the renminbi has risen by about 14 per cent over the same time. Whichever measure you use this is quite a move, and one with powerful consequences.


For those minded to look, there is plenty of evidence that China’s economy is already changing for the better. Take its October trade data. The massive increase in the size of its trade surplus – which rose to $27.1bn – got all the attention. But in the first 10 months of 2010 China’s surplus has only been around 3.2 per cent of gross domestic product, around a third of its peak before the financial crisis.


China’s current account surplus also looks large: the International Monetary Fund thinks it will be $270bn this year. But as a proportion of GDP this surplus will probably not be much more than 5 per cent, about half its peak. The trade surplus has declined even more; this year it will likely be below 4 per cent of GDP, again less than half its recent peak. There are also widespread reports that rising costs mean international companies no longer see China as a low-cost option for their production, which could lower the trade surplus further. No wonder China is mulling a commitment to keep its current account surplus below 4 per cent of GDP; it is already not far off.


Some claim that these improvements are only temporary, and merely reflect a sharp drop in demand for China’s exports – especially in the US. But if that were true, why are Chinese imports now about $400bn higher than in 2009, an amount bigger than the Greek economy? Here strong Chinese domestic demand should take the credit, something that benefits countries with strong exporters, like Germany. Some are not benefiting, of course, but that is not a reason to blame China for engaging in a currency war. Indeed, the US might even see its own exports rise at some stage.


At the recent meeting of the Group of 20 leading nations, many began to accuse the US of playing its own part in this war game, following the Federal Reserve’s decision to pump $600m into America’s economy. But the Fed’s responsibility is to maintain high employment and low inflation, not currencies. A lower dollar might be a consequence of the Fed’s policies. But as and when it succeeds, and the economy recovers, so will the dollar. This is what happens with floating exchange rates.


Various countries have also been intervening to stop currency appreciation in recent months; some occasionally, others more often. But to take just the examples of Brazil, Japan and Switzerland, each has some perfectly legitimate excuse for their actions, given that their currencies do appear to be overvalued. Again, the war-like language is inappropriate.


Amid all of this overheated talk, there is only one point where those who attack China as undervalued have a credible point: the growth of its foreign exchange reserves, which now sit above $2,500bn. But even here we must recognise China’s sizeable inward investment flows. This means its basic balance of payments, which includes capital inflows, is much stronger even than its recently improved current account. Some of this has been sensible, although some of it stems from needless reserve accumulation designed to avoid a repeat of the 1998 Asian crisis.


We are living through an era in which development is lifting millions out of poverty. China is at the forefront of this process, with an economy that has tripled in size in a decade. The other Bric nations of Brazil, Russia and India are important too, alongside various emerging economies. These remarkable developments are not those you would normally associate with war-like conditions.


As we progress through this decade, further growth will reverse the global imbalances that lie at the heart of the current currency debate. And as this unfolds, through the ebb and flow of foreign exchange movements, our system of floating rates will demonstrate its utility. It will ultimately deliver much more sense than many of those who currently opine about it.


The writer is chairman of Goldman Sachs Asset Management


Copyright The Financial Times Limited 2010.