Wednesday, October 13, 2010

More On Currency Wars

More on the ongoing currency wars, this time from the FT's Martin Wolf.

Last week I posted a note that cited the German magazine Der Spiegel. Seen from the German point of view, the American demands for the Chinese to allow the markets to set the appropriate rate for the Chinese yuan seems hypocritical, given our benign neglect of the dollar as a way to boost our economy.

Here was the quote from the article posted on October 6:

There is, however, also a fair amount of hypocrisy behind the latest American initiative. Nobody has controlled the currency markets as much as the US has in the past. The US Federal Reserve still continues to print dollars to finance skyrocketing government debt. The fact that this erodes the value of the US currency is something that the Americans seem not to care about. Of course, this makes imports into the US more expensive, but it also makes American exports cheaper and enhances the competitiveness of US companies.

In yesterday's FT, Mr. Wolf notes that in a currency war the U.S. is sure to win, at least in the short term, since we control the world's reserve currency:

Above all, today’s low and falling inflation is potentially calamitous. At worst, the economy might succumb to debt-deflation. US yields and inflation are already following the path of Japan’s in the 1990s (see chart). The Fed wants to stop this trend. That is why another round of quantitative easing seems imminent.

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. / Columnists / Martin Wolf - Why America is going to win the global currency battle

In my opinion, however, I am still not convinced that merely depreciating the dollar will solve all of our ills. On the other hand, there seems little doubt that trade wars waged by currencies can turn into mutually assured destruction.

Finally, I would note the following news item today, which underscores the urgent need that most of the world feels to do something about the huge trade imbalances (from today's New York Times):

SHANGHAI — China said Wednesday that its exports continued to surge in September and that the nation’s foreign exchange reserves ballooned last month, data that is likely to keep pressure on Beijing to appreciate its currency.

The government said its monthly trade surplus reached $16.9 billion in September, with exports up 25 percent and imports climbing 24 percent.

The surplus narrowed from August, when it had reached $20 billion, but it was still an enormous figure, analysts said.

Also Wednesday, Beijing said its foreign exchange reserves soared $194 billion in September to a record $2.65 trillion, far more than economists had forecast. China already had, by far, the world’s largest currency reserve holdings.