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…