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International Monetary Fund powerless to act

The word ‘war’ has been on the lips of international negotiators in recent months. This is nothing to do with Afghanistan or Iraq, but is just as significant. This is about the possibility of a global currency war.

There are imbalances in the global economy which were at the heart of the recent collapse of the world economy. What are these imbalances?

The basic answer is that some countries have been so good at exporting that they have built up huge current account surpluses, with China being the main surplus nation. According to the IMF China has currency reserves of $2.447 trillion. This is a lot of money. In fact, this is the largest surplus in the world and accounts for 30% of the global total.

Obviously something has to be done with these reserves, and China and other nations in a similar position have been pouring money into the sophisticated financial markets of the west. As this money has poured in it has financed the recent booms in housing markets and other assets, which ultimately triggered the recent world recession.

The solution is clear. China has to sell fewer exports, and countries such as the US and UK have to buy fewer imports. The problem is that China’s exports are sold at such an enticing price that the west cannot seem to resist them. But, the US and others have cried “foul” because they believe that the Chinese currency, the Yuan, is artificially undervalued, making Chinese exports cheaper than they should be. The US has appealed to the “referee” in the form of the IMF to do something about it.

Will global imbalances lead to currency wars?

However, the IMF has been unable to reach agreement between the main protagonists. In fact, the statement which came out of the weekend’s annual IMF-World Bank meetings, said that the IMF pledged to “work towards a more balanced pattern of global growth, recognising the responsibilities of deficit and surplus countries.” In other words, they were going to keep their fingers crossed and hope for the best.

You can understand the position of China and Germany which run huge trade surpluses. They are being asked to run-down their surpluses and sell fewer goods overseas. The Chinese, in response, are refusing to revalue their currency on anything more than a gradual basis.

In fact, the international monetary system, set up after the end of the second world war, acts in an asymmetric fashion. All the emphasis has always been put on the debtor nations – the ones running the current account deficits. They have always been “leaned on” to deflate their internal economies to reduce prices and make themselves more competitive. In other words, if there was any medicine to be taken, it was the debtor countries which should be taking it.

Originally, this system worked in favour of the US, but the world economic situation has moved full circle over the past sixty years, and has come back to bite them in the backside.

The US is currently experiencing deep problems. Latest figures show that US non-farm employment fell by 95,000 in September and unemployment now stands at 9.6% of the workforce. The US has also not recovered from the collapse in its housing market.

One solution would be for the Chinese to announce a gradual revaluation of the Yuan over the medium term, but they have shown a reluctance to see any significant appreciation of their currency. They believe that this would cause an unsustainable upheaval in the social fabric of their developing economy.

On the other side the US is losing patience. A “jobless recovery” is not going down well with the American people. The US does not have the upper hand and currently can only argue their case. However, if there is not significant movement from the Chinese the US may well impose protectionist measures to keep Chinese goods out of their country.

A return to the so-called “beggar-thy-neighbour” policies of the 1930s are a definite option, but will ultimately benefit no-one. If this problem is not solved, the world can easily dip back into recession.

Dominique Strauss-Kahn, managing director of the IMF, said that he didn’t “believe action can be done in a way other than in a co-operative way.” So it seems it must either be “co-operation” or “war”.

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Posted in China, Exchange Rates, International Monetary Fund, International Trade, Protectionism, US economy, World Trade

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