It's the silly season for currency interventions. Last week, , finance minister of Brazil warned an 'international currency war' has broken out. As Brazil's central bank scrambled to buy close to $1 billion a day for almost two weeks - about 10 times its daily average - Mantega was only voicing what many governments have already expressed privately. That for all the calls for collective action and bonhomie displayed at various meetings, when it comes to ground realities, it is each country for itself!
So, what's new about that? What is new is that unlike in the past when 'currency intervention' was always a developing country refuge, a third world stratagem that first world countries eschewed, this time round, first world countries are nothing loath to join the game.
Last month, Japan joined Switzerland in intervening in the foreign-exchange market. As the yen surged to a little short of 90 to the dollar, the strongest in 15 years, the central bank, fearing a strong yen, would jeopardise recovery, sold an estimated $20 billion yen. The last time it intervened to sell yen in the foreign-exchange market was in 2004, when the yen was around 109 per dollar.
It is not the only one. The Swiss central bank has been intervening to prevent the appreciation of the Swiss franc against the euro for close to six months now. The last time it intervened was in 2002. The Japanese and the Swiss are not alone. South Korea, host to the next G20 meet, has shown as much alacrity in intervening to keep the won weak; so have Taiwan and Singapore.
In the developing world, meanwhile, currency intervention has become much more frequent. China, an old hand at the game, has been joined by Brazil, the Philippines, India and Malaysia, to mention just a few. The danger is if intervention becomes the norm, rather than the exception, the resultant 'currency war' will not leave any winners. Worse, it will mean goodbye to any hopes of rebalancing the world economy.
Why is that important? Because as long as the global economy remains perilously unbalanced, the next crisis is not far away. Orderly currency realignment is, therefore, critical to rebalancing. But that calls for coordinated action by the major world economies (read G20) - not haphazard, beggar-myneighbour intervention of the kind that seems to be the fashion now.
The reason is simple. Cheap money policy in the US that causes the dollar to weaken against other currencies will help boost US exports and rein in the US current account deficit. Provided no country intervenes! So, left to itself, this realignment in currency values is a part of the remedy the world is seeking.
But this is where the catch lies! China, the world's largest exporter, continues to suppress the value of the renminbi. In the pre-crisis days, when economic growth was strong, most countries were prepared to look the other way and restrict their response to jaw-jaw. Not any longer! Today, as countries struggle to remain competitive in the global market, many seem to have decided to copy the Chinese. Hence the proliferation of currency interventions aimed at making currencies cheaper in order to boost exports.
So, what's new about that? What is new is that unlike in the past when 'currency intervention' was always a developing country refuge, a third world stratagem that first world countries eschewed, this time round, first world countries are nothing loath to join the game.
Last month, Japan joined Switzerland in intervening in the foreign-exchange market. As the yen surged to a little short of 90 to the dollar, the strongest in 15 years, the central bank, fearing a strong yen, would jeopardise recovery, sold an estimated $20 billion yen. The last time it intervened to sell yen in the foreign-exchange market was in 2004, when the yen was around 109 per dollar.
It is not the only one. The Swiss central bank has been intervening to prevent the appreciation of the Swiss franc against the euro for close to six months now. The last time it intervened was in 2002. The Japanese and the Swiss are not alone. South Korea, host to the next G20 meet, has shown as much alacrity in intervening to keep the won weak; so have Taiwan and Singapore.
In the developing world, meanwhile, currency intervention has become much more frequent. China, an old hand at the game, has been joined by Brazil, the Philippines, India and Malaysia, to mention just a few. The danger is if intervention becomes the norm, rather than the exception, the resultant 'currency war' will not leave any winners. Worse, it will mean goodbye to any hopes of rebalancing the world economy.
Why is that important? Because as long as the global economy remains perilously unbalanced, the next crisis is not far away. Orderly currency realignment is, therefore, critical to rebalancing. But that calls for coordinated action by the major world economies (read G20) - not haphazard, beggar-myneighbour intervention of the kind that seems to be the fashion now.
The reason is simple. Cheap money policy in the US that causes the dollar to weaken against other currencies will help boost US exports and rein in the US current account deficit. Provided no country intervenes! So, left to itself, this realignment in currency values is a part of the remedy the world is seeking.
But this is where the catch lies! China, the world's largest exporter, continues to suppress the value of the renminbi. In the pre-crisis days, when economic growth was strong, most countries were prepared to look the other way and restrict their response to jaw-jaw. Not any longer! Today, as countries struggle to remain competitive in the global market, many seem to have decided to copy the Chinese. Hence the proliferation of currency interventions aimed at making currencies cheaper in order to boost exports.
The problem is this 'if you can't beat them, join them' philosophy could be catastrophic for global recovery. As each country looks to its own backyard, it is going to become much more difficult to reach a consensus on currency realignments. Exactly 25 years ago, the major global economic powers could hammer out the Plaza accord that led to an orchestrated weakening of the dollar, a resurgence of the US economy and a corresponding decline of the Japanese.
That was possible back in the 1980s as the US was the unchallenged economic superpower. Today, such a onesided accord would be almost unthinkable. South Korea, the host of the upcoming G20 meeting in November, is reluctant to even highlight the issue on the agenda, partly out of fear of offending China, its neighbour and main trading partner.
Yet, there is no getting away from the need for some kind of coordinated action. A situation where every country intervenes against its own currency in the foreign exchange markets in a spirit of competition rather than cooperation is not a zero-sum game. Smaller, lesscompetitive countries like India are bound to get hurt more.
Moreover, intervention comes at a cost. In the Indian context, accumulation of foreign exchange reserves and release of additional liquidity into the system adds to domestic liquidity, neutralising the RBI's efforts to tighten liquidity to rein in prices. The additional liquidity could be sterilised but sterilisation, too, has a cost since the domestic rate of interest is usually higher than the return on foreign exchange reserves.
Non-intervention is not an option either; not in a scenario where more and more countries are intervening. An undue appreciation of the rupee vis-à-vis other currencies is bound to hurt exports and in turn, hurt employment.
So where does that leave us? If both intervention and non-intervention are bad, what is the only option that remains? Global cooperation! For the moment, however, coordination seems further away than ever. In a fresh signal that it is each country for itself, last week the passed a Bill to allow levy of countervailing duties on imports from China in order to compensate for the weak renminbi.
In a globalised world if each country behaves like (who once famously retorted 'our currency, your problem,' to a European delegation worried about the impact of a cheap dollar on their exports) and starts a competitive devaluation of its currency, the resultant fallout will soon encompass the whole world.
If the slogan of the forthcoming G20 meet in Seoul, 'shared growth beyond crisis,' is to be realised, the G-20 must act before it is too late. Before the cocky 'our currency, your problem' approach that seems to colour every country's approach today gives way to a humbler but truer 'your currency, our (collective) problem' view, that should inform our 21st century world!
That was possible back in the 1980s as the US was the unchallenged economic superpower. Today, such a onesided accord would be almost unthinkable. South Korea, the host of the upcoming G20 meeting in November, is reluctant to even highlight the issue on the agenda, partly out of fear of offending China, its neighbour and main trading partner.
Yet, there is no getting away from the need for some kind of coordinated action. A situation where every country intervenes against its own currency in the foreign exchange markets in a spirit of competition rather than cooperation is not a zero-sum game. Smaller, lesscompetitive countries like India are bound to get hurt more.
Moreover, intervention comes at a cost. In the Indian context, accumulation of foreign exchange reserves and release of additional liquidity into the system adds to domestic liquidity, neutralising the RBI's efforts to tighten liquidity to rein in prices. The additional liquidity could be sterilised but sterilisation, too, has a cost since the domestic rate of interest is usually higher than the return on foreign exchange reserves.
Non-intervention is not an option either; not in a scenario where more and more countries are intervening. An undue appreciation of the rupee vis-à-vis other currencies is bound to hurt exports and in turn, hurt employment.
So where does that leave us? If both intervention and non-intervention are bad, what is the only option that remains? Global cooperation! For the moment, however, coordination seems further away than ever. In a fresh signal that it is each country for itself, last week the passed a Bill to allow levy of countervailing duties on imports from China in order to compensate for the weak renminbi.
In a globalised world if each country behaves like (who once famously retorted 'our currency, your problem,' to a European delegation worried about the impact of a cheap dollar on their exports) and starts a competitive devaluation of its currency, the resultant fallout will soon encompass the whole world.
If the slogan of the forthcoming G20 meet in Seoul, 'shared growth beyond crisis,' is to be realised, the G-20 must act before it is too late. Before the cocky 'our currency, your problem' approach that seems to colour every country's approach today gives way to a humbler but truer 'your currency, our (collective) problem' view, that should inform our 21st century world!
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