We may be on the brink of a currency war, which could have devastating effects on the global economic recovery. The Americans accuse the Chinese of forcing the value of the renmimbi down artificially in order to maintain growth in their export sector. The Chinese accuse the Americans of stimulating inflation in the developing nations with their ultra low interest rates. The Japanese government is selling yen in an attempt to keep its value from rising. The Brazilians have imposed capital controls to try and reduce foreign inflows so as to maintain their competitiveness. And this weekend’s IMF meeting of central bankers and finance ministers ended badly, with mutual recriminations. It looks like we may be about to return to the 1930s’ Beggar Thy Neighbour policies of competitive devaluation, trade barriers and capital controls.
In a recession, it is natural to try to lower unemployment and increase domestic demand by stimulating exports. If foreigners buy more of our goods, then employers in the export sectors will hire more workers. To increase exports, just lower costs. And the easiest way to lower costs is to devalue your currency. If your currency falls by 25%, so does the cost of your goods in foreign markets. Bada bing, your sales rise and jobs return.
That is how the East Asia tigers recovered so quickly from their financial crisis back in the late 1990s. As the value of the baht and the won fell, the export sectors of Thailand and South Korea boomed and soon their economies were back on track. The problem today is that our slowdown is global. Every country wants to export its way out of the crisis. But since my exports are somebody else’s imports, my devaluation, while adding jobs in my country is taking them from another.
One of the underlying causes of our Great Recession is global imbalances between the surplus nations (China, Germany, Japan) and the deficit nations (Great Britain, the USA, Spain, Greece, Portugal). China and Germany, with their powerful export sectors were able to keep employment booming by lending money to the deficit nations which could then use them to buy their goods. The balance of trade deficits were financed by loans from the surplus nations.
Back in the happy days of the boom, we thought this was win win. We got to consume more than we produce, the Chinese got to create jobs and keep their economy expanding. But if an American doesn’t max out his credit card, a factory in China closes. Our ever-growing levels of debt allowed aggregate demand to keep rising and so the global economy booming.
The credit crunch and the subsequent deleveraging put an end to that pleasant scenario, however. Households in the deficit countries are now trying to pay off their debts, corporations are holding onto their cash. So consumption and investment are stagnating. For a while increased government spending maintained aggregate demand but today many governments fear their exploding budget deficits and reject increased fiscal stimulus.
The deficit nations want the surplus nations to consume more and save less. But the surplus nations, scornful of our grasshopperish ways, reject the idea that they are responsible for our debts. The Chinese fear that a pricier renmimbi will cost them jobs. The IMF had hoped that a global consensus could be found. Last weekend’s meeting suggests that it is going to be every nation for itself.
Back when I was studying the Great Depression, my professors had nothing but scorn for the Beggar Thy Neighbour policies of the 1930s. These policies, by lessening world trade, were clearly destructive to global growth and some suggest played a part in causing World War II. We students thought the world had learned from the failure of these policies. Perhaps not.