|SocialismToday Socialist Party magazine|
Currency war - Clashes escalate crisis
The currency war threatens to develop into an open trade war, with beggar-my-neighbour protectionist measures. Currency and trade conflicts will drive the world capitalist economy into even deeper crisis. Faced with growing tensions, the G20 leaders are in disarray. LYNN WALSH analyses the situation.
“WE’RE IN THE midst of an international currency war…” This complaint came from Guido Mantega, Brazil’s finance minister, at the recent International Monetary Fund (IMF) meeting in Washington DC. Brazil is one of the countries that has been affected by an inflow of speculative capital, pushing up its currency and undermining its competitiveness on world markets. Beggar-my-neighbour currency measures were, in fact, the most urgent issue facing the IMF leaders. No agreement was reached, however, and the issue was postponed to the G20 summit in South Korea in November. Pascal Lamy, head of the World Trade Organisation (WTO), warned that growing currency tensions risked the return of 1930s-style protectionism. He warned of “a domino effect, where you get a beggar-my-neighbour, or tit-for-tat, chain and it sours and sours”.
It is unlikely that any substantial agreement will be reached at the Seoul meeting. As the feeble ‘recovery’ of the world economy began to falter earlier this year, major G20 governments turned to ‘fiscal consolidation’, replacing state stimulus with severe cuts in state expenditure. In a desperate attempt to promote growth, they have turned towards export markets. But, as the IMF’s own World Economic Outlook puts it, “not all countries can have real depreciation and increase their net exports at the same time”.
Some temporary compromise may be patched up at the Seoul meeting. It will inevitably be temporary, however, and break down as competition between national economies intensifies. The US Federal Reserve, for instance, has now signalled that it intends to implement a new round of quantitative easing, printing money with the aim, among others, of bringing about a further devaluation of the dollar to promote US exports. This, as the Chinese leaders point out, amounts to a unilateral devaluation of the dollar to promote US interests at the expense of the rest of the world.
In response, the Chinese regime has restricted the export of rare earths, first to Japan and now to Germany, the US and other importers. (Rare earths are chemical elements that are essential to the production of many high-tech products; China currently controls over 90% of world production.) This is a signal that China will not passively accept the self-interested measures of US capitalism.
Britain, moreover, has announced that it will follow the US example. Mervyn King, governor of the Bank of England, has announced a new round of quantitative easing, which is undoubtedly aimed at a further devaluation of the pound in an effort to promote British exports.
During the last two or three years, the currency wars and growing trade frictions have been on the level of warning shots rather than all-out conflict. All the signs are that this conflict is beginning to intensify: “a currency war… could lead to disaster if losing countries with expensive exchange rates were to resort to orthodox trade tariffs – a measure that would be logical, and might well be politically necessary for them”. (John Authers, Everyone Will Lose in a Global Currency War, Financial Times, 8 October)
The US threatens sanctions
IN RECENT MONTHS, the US has stepped up pressure on China to revalue the yuan (or rmb), though so far the Obama administration has stopped short of declaring China guilty of ‘currency manipulation’, a move that would trigger trade sanctions. With the mid-term elections imminent and unemployment still officially over 10%, Barack Obama is under intense pressure to curb China’s exports to the US. This pressure is reflected in a recent op-ed article in the New York Times by Sherrod Brown, a Democratic senator from Ohio. “Inexpensive products [from China] might sound nice, but we lose 13,000 net jobs for every $1 billion increase in our trade deficit. Our $226 billion deficit with China has meant shuttered factories, lost jobs and devastated communities across America”. (17 October) Brown is demanding “punitive steps in response to China’s unfair trade practices”.
The huge US trade deficit with China is undoubtedly widely seen by workers as the result of the Chinese regime’s manipulation of its currency. US corporations, of course, were only too pleased to relocate their factories in China, taking advantage of cheap labour and a low-cost environment. Moreover, cheap imported goods in the United States allowed big business to pay low wages to US workers. Sooner or later, however, this unbalanced relationship between debt-financed consumption in the US and low-cost production in China was bound to become unsustainable.
In September, the US House of Representatives passed a bill, supported by Democrats and Republicans, that would treat imports benefitting from an undervalued yuan as benefitting from subsidies, subjecting them, according to WTO rules, to anti-dumping tariffs. (Whether this is really compatible with WTO rules is a moot point.) To become law, a similar bill would have to be passed in the US Senate and approved by Obama. However, the threat of this legislation adds to the pressure on the Chinese regime at IMF and G20 talks.
Obama has already accepted a petition from the US steelworkers’ union demanding an investigation of Chinese government subsidies of green energy exports. The Chinese government, for its part, counters this allegation with claims that the US government subsidises green energy products to the extent of $60 billion and complains that the US government imposes ‘buy American’ clauses on the public procurement of certain green energy products.
Obama and his treasury secretary, Timothy Geithner, at this stage, seem hesitant to formally declare China guilty of ‘currency manipulation’ – from fear of setting off a tit-for-tat currency and trade war. The US would prefer to push the Chinese government into a revaluation of the yuan by stepping up the pressure on various fronts, rather than declaring open war.
THE US, HOWEVER, is about to escalate the currency war on another front. The US Federal Reserve is about to launch ‘QE2’, a second round of quantitative easing. This new resort to the printing press is intended, domestically, to increase the flow of credit into the economy and stimulate investment and consumer demand. Another aim of this measure, however, is clearly to accelerate a decline in the value of the dollar.
The US no longer has the international weight that it had in 1985 when, under the so-called Plaza accord, it pushed Germany, Japan, Britain and France into an agreement which allowed a dramatic revaluation of the yen and a rapid (50%) decline of the dollar. “Significantly, in the eyes of many countries, the United States has lost some of the standing it needs to shape global policy. Not only is Wall Street viewed by many as having initiated the world financial crisis, but also a number of countries fear that policies by the Federal Reserve are pushing down the dollar's value – the same kind of currency weakening for which the Obama administration has criticised China”. (Sewell Chen, Currency Rift with China, New York Times, 10 October)
This time, the US is acting unilaterally by printing dollars. Once again, the US is taking advantage of the role of the dollar as the world’s major reserve currency to finance investment and pay off its debts in its own currency.
The dollar has declined approximately 20% (against a basket of currencies of its main trading partners) since its 2003 peak, and will no doubt fall rapidly as a result of renewed quantitative easing. International speculators will turn away from the dollar as its value falls, thereby accelerating the decline. The big investors will turn on an even bigger scale to the so-called ‘emerging markets’, the semi-developed economies like Brazil, Indonesia, Thailand, etc. The flood of speculative capital (based on borrowing cheap dollars in a new phase of the ‘carry trade’) will push up the value of the target currencies, compounding the global currency tensions.
But what will happen to the yuan? If the yuan were allowed to float, it would clearly appreciate against the dollar. But it is virtually ruled out that the Chinese regime would allow an uncontrolled appreciation of their currency, which would have a devastating effect on China’s exports. But if it maintains the peg with the dollar, the advantage for the US of a falling dollar will be largely cancelled out with regard to China. This last scenario would almost certainly lead to protectionist measures being adopted by the US against China’s exports.
In the run-up to the G20 meeting in November, there is intense behind-the-scenes pressure to reach an agreement for a coordinated realignment of the world’s major trading currencies, particularly the dollar-yuan relationship. Some form of agreement may be reached. But any realignment will be temporary: it will inevitably break down under the pressure of contradictory developments in the world economy in the next period.
For instance, US big business, backed by the Obama administration, wants an export-led recovery (given the weakness of consumer demand under conditions of a huge credit overhang and mass unemployment at home). However, this will not be achieved merely by a realignment of currencies. Under globalisation, deindustrialisation in the US has been in progress for three decades. Many consumer goods are no longer produced in the US. An export-led recovery would require massive investment (in the face of global overcapacity and weak profitability) and structural changes in the US economy. At the very least, it would take a period of sustained investment and growth to achieve such a reorientation.
There is also the problem that all the main industrial or semi-industrialised economies are trying to achieve recovery through export-led growth. There is a fundamental problem of overcapacity and shrinking demand, which will be intensified by a reduction of US demand for imports (as the falling dollar makes them less affordable). The role of US capitalism as the ‘market of last resort’ was a crucial factor in global growth since the mid-1990s. A weak US market will have a devastating effect on the world economy.
There is also the problem that the US has depended on China to finance its massive debt, both its federal government deficit and the accumulated trade deficit. China has accumulated $2.45 trillion of foreign currency reserves (65% in dollars, 26% in euros). China is the biggest holder of US government bonds (with $843.7bn) and altogether holds a total of $1.5 trillion in US securities of all kinds (bonds, shares, etc).
US leaders may hope that they can find new creditors and also reduce the US’s external debts. However, as the dollar falls, US financial assets (whether federal government bonds or company bonds) will become much less attractive investments. Moreover, a rapid reduction of the external debt would imply a sharp contraction in the US economy, which would counteract the effect of increased exports (if that were achieved).
Given the international role of the dollar (which is not likely to be replaced by the euro or any other currency in the foreseeable future), QE2 gives the US a powerful weapon. There is no doubt, however, that US leaders are wary of retaliation from China and other countries. As a warning, the Chinese regime recently displayed its ruthlessness in a dispute with Japan. The immediate issue was the arrest of the captain of a Chinese vessel by the Japanese authorities, for allegedly entering Japanese territorial waters around the disputed islands of Senkaku/Diaoyu. China retaliated by halting the export of rare earths to Japan, essential materials for many electronic products. In the scale of things, this was a minor spat. Nevertheless, it reflects the underlying struggle for economic dominance and regional strategic power, factors which undoubtedly come into play in the currency/trade conflict.
China hits back
THE CHINESE REGIME rejects the idea that China is to blame for the imbalances in the global economy. In particular, it dismisses claims that China’s ‘excess’ savings or the weakness of its domestic market are the primary cause of the US’s international trade deficit, and its ever-growing bilateral deficit with China (now over $200bn a year). The US’s problems, according to the Chinese leaders, are self-inflicted, a result of ‘excessive’ credit and, more recently, an ultra-loose money policy, which is increasingly destabilising the global economy.
In fact, China and the US represent two sides of a contradictory relationship: with credit-driven consumption in the US (producing a growing federal deficit and massive trade deficit), on the one side, and an export-driven economy on the other, with China using its huge accumulated foreign currency surpluses to finance US debt. This imbalanced relationship clearly cannot be sustained indefinitely. Conflict over the global currencies is not a failure of coordination but a symptom of this antagonistic relationship.
The Chinese regime has followed a policy of export-led growth, with an undervalued yuan as a key part of this strategy. An undervalued yuan makes China’s exports cheap for US, European and other markets, while making imports more expensive, thus limiting the growth of domestic consumer spending. For years, China has effectively pegged the yuan to the dollar, thus frustrating any gain for US exporters to China as the dollar falls. The de facto yuan-dollar peg also strengthens China’s competitive position against other semi-developed economies, whose currencies have appreciated against the dollar in the recent period.
It is claimed that the yuan is currently 20-40% undervalued. The Chinese government has played a cat-and-mouse game with the US, continually promising reforms (with the prospect of a gradual yuan revaluation) but continually prevaricating. In June, China took the yuan off the dollar peg. However, it has risen in value since then by less than 2%, as China has been buying dollars, euros, etc, to prevent a big appreciation.
Instead of using its huge profits from foreign trade to develop the home market and raise the living standards of workers and farmers, the Chinese regime has hoarded its foreign currency earnings, separating them from the internal economy. It has used its reserves to buy US dollar assets, particularly US government bonds, which effectively is a key support for the continued credit-driven US economy.
During the global downturn in 2008-09, the Chinese regime massively increased state (or state-financed) stimulus packages, particularly in infrastructure projects. This policy was undoubtedly a crucial factor in maintaining the high growth rate in the Chinese economy (which, in turn, partially cushioned the global downturn). China’s massive stimulus package has had a significant effect both at home and on the world economy.
The Chinese leaders are far from abandoning their export orientation. They saw the massive intervention at home as a temporary expedient pending the revival of exports to the US, Europe and the rest of the world. No doubt they would like to see a more balanced development, with stronger growth of the domestic economy. However, the orientation of the economy has structural dimensions, which cannot be rapidly changed.
Above all, the regime fears social upheaval unless it can guarantee continuous growth and avoid mass unemployment. Visiting Europe for the recent IMF meeting, the Chinese prime minister, Wen Jiabao, delivered a clear warning to western leaders: “Do not work to pressurise us on the renminbi rate”. Chinese export companies, he said, have very small profit margins, which could be wiped out by US protectionist measures. “Many of our exporting companies would have to close down, migrant workers would have to return to their villages”, Wen said. “If China saw social and economic turbulence, then it would be a disaster for the world”. (Financial Times, 6 October)
At the same time, the governor of China’s central bank, Zhou Xiaochuan, warned the IMF meeting that the focus on currencies was one-sided. “The continuation of extremely low interest rates and unconventional monetary policies [meaning quantitative easing] by major reserve currency issuers have created stark challenges for emerging market countries in the conduct of monetary policy”. Among other things, the flood of speculative capital into commodity-exporting economies has pushed up the price of raw materials for Chinese industries.
Faced with intensified pressure from the US (with the prospect of protectionist trade measures in the coming months), the Chinese regime has shown that it will not passively accept sanctions, but will pursue its own counter-measures. For instance, China recently began to buy yen, which pushed up the value of the Japanese currency. This pushed up the prices of Japanese exports on world markets, with serious consequences for the export-oriented Japanese economy. To try to mitigate this effect, the Bank of Japan began buying up US dollars. (Selling yen tends to lower the exchange value of the yen, while buying dollars should push up the value of the dollar.) However, even though the Bank of Japan spent many billions of yen in this operation, it failed to have more than a very temporary effect on the parities of the yen and the dollar.
China’s action in September, however, was a warning of future manoeuvres in the event of an all-out currency war. Buying US dollars to keep down the value of the yen, Japan was “in effect doing China’s currency manipulation for it. China gets a more diversified portfolio, insurance against any fall in treasuries, and still gets its near-term goal of a continued strong dollar and the exports in jobs that means”. (James Saft, China Runs Circles Around Adversaries, Reuters, 5 October) In other words, Japan gets the blame for currency manipulation and bears the losses when the dollar falls again.
Moreover, while in Europe for the IMF meeting, Wen announced that China would be buying more euro bonds, including Greek government bonds. China, he said, was interested in supporting the stability of the euro. However, the real motive is undoubtedly to prevent a massive fall in the value of the euro, which would strengthen eurozone competitors against China.
IT IS SIGNIFICANT that the most outspoken warning of a currency war came from Mantega, Brazil’s finance minister, and from other leaders of so-called ‘emerging markets’, the semi-developed countries of the neo-colonial world. Following the downturn in the advanced capitalist countries, there has been a flood of capital into these economies. Their growth rates have been higher than the advanced economies, to a large extent sustained by China’s demand for raw materials. Cheap credit in the advanced countries, expanded by quantitative easing, has produced a wave of speculative investment in the semi-developed countries, where interest rates and profits are currently higher than in the advanced capitalist countries. Potentially dangerous bubbles are clearly developing.
At the same time, the flood of capital is pushing up the value of these countries’ currencies, making their exports less competitive. The currency appreciation, complained Mantega, “threatens us because it takes away our competitiveness”. Indeed, the semi-developed economies that have weathered the great recession (largely on the basis of foreign investment and China’s demand for raw materials) will face their own crisis in the next period.
The semi-developed economies piled up foreign currency reserves after the 1997 Asian currency crisis as so-called ‘self-insurance’ against any renewed runs on their currencies or their credit. Reserves were generally reduced during the 2008-09 downswing, as governments increased state expenditure to counter the effects of world recession, but they have since recovered and exceeded previous levels.
Different countries have resorted to various measures to counter currency appreciation. Some, like Chile, South Korea and Indonesia have imposed capital controls and taxes on inward investment. Others, like Brazil, have been intervening in currency markets, buying dollars with their own currency in an effort to limit appreciation of their currency.
Such intervention, however, has only a limited effect. Without agreement between the advanced capitalist countries and the major semi-developed economies, it is impossible to establish any kind of stability merely through intervention in the markets. The global situation is much more complex than in 1985 when five major powers agreed, under the Plaza accord, to bring about a revaluation of the yen and the devaluation of the dollar.
Over $4 trillion flow across the world’s foreign exchanges every day, according to the Bank for International Settlements’ latest triennial survey. This is a 20% increase over April 2007, in spite of the downturn in the world economy. It is impossible for national governments to intervene on a big enough scale, and for a long enough period, to bring about any lasting realignment of currencies. China has partially insulated itself by maintaining strict capital controls and maintaining its foreign currency reserves outside the domestic economy. On the other hand, the US is now planning to bring about a massive, unilateral devaluation of the dollar through a new round of quantitative easing.
At present, the measures to counter adverse currency alignments (whether through controls or intervention) are mostly defensive – aptly described as ‘competitive non-appreciation’ – attempts to protect national economies against global trends. At a certain point, however, currency measures will give way to open protectionism, with a resort to import controls (through quotas or tariffs or a combination of both). The current phony currency war, unless there is a real recovery in the world economy (which seems unlikely at the moment), will turn into a more bloody conflict, paving the way in turn for open protectionism. Such a development would represent a new stage in the development of the world crisis of capitalism.
It didn’t work
“IT WORKED!” AFTER the Pittsburgh summit (September 2009), the G20 leaders congratulated themselves that, through ‘co-ordinated’ state bailouts of the banks and stimulus packages, they had avoided a catastrophic slump. It was a case, however, of parallel action rather than co-ordination. Having avoided another ‘great depression’, most of the major capitalist economies are now striving to sharply reduce the fiscal deficits produced by the downturn and emergency state measures. Stimulus has been replaced by austerity (so-called ‘fiscal consolidation’), which has already slowed the growth in the advanced capitalist countries, threatening a double-dip recession, or worse.
With retrenchment at home, the capitalist governments are seeking growth through exports, all competing for the same limited markets. The ‘co-ordination’ of last year has been replaced by competitive devaluations and creeping protectionism. Without a marked recovery of the world economy, which does not appear to be likely, the current currency wars will escalate into trade wars. This is already indicated by the protectionist threats by the US administration and Congress and the retaliatory measures by China (restricting the exports of rare earths to Japan, the US, and Germany).
No doubt, capitalist leaders fear a return to the protectionism of the 1930s, which strangled world growth (at a time when national economies were less interconnected than now). A period of weak, fragile growth (with a weak business cycle) will bring increased competition between rival capitalists, with the ruthless pursuit of national interests – inevitably bringing more beggar-my-neighbour measures. This is the brutal logic of capitalism. But protectionism, whatever form it takes, will not provide a way out for capitalism. On the contrary, it will drive the system even deeper into crisis.