By
Marc Chandler
:
(This is a summary of my views on "currency wars" that was
the topic of the recent panel discussion at SIBOS in which I
participated.)
A standard ploy of magicians and politicians is called
misdirection. The audience is distracted from the real movement by
a feint. "Currency war," which has become the title of books,
articles and conferences, is such a misdirection.
Some officials, notably Brazilian Finance Minister Guido
Mantega, have been leading the charge that through pursuing
unorthodox monetary policy, the U.S. has sparked powerful forces
that destabilize the emerging market economies through capital
flows, driving the currencies sharply higher.
Emerging Markets
It is indisputable that international capital movement is
volatile and that the accommodative monetary policy in the U.S.,
and other developed economies, has shifted interest rate
differentials more in favor of emerging markets. This shift has
likely spurred private capital flows. That is both a common ground
and a point of departure.
Capital inflows into the emerging markets are driven by a number
of considerations, not just interest rate differentials. Consider,
for example that growth differentials and higher returns on
investment have also been attracting investment flows, especially
in recent years.
The general investment climate is shaped in part by the risk
appetite of investors. The risk-on and risk-off matrix has shifted
in recent years, not as much by the pursuit of U.S. monetary policy
as by the shifting response to the European debt crisis.
In a recent speech, Federal Reserve Chairman Bernanke cited
research by the IMF and others that concluded that monetary
policies of the advanced economies were not the dominant drivers of
private savings into emerging markets. He went further and noted
that capital flows into emerging markets have slowed considerably
over the past couple of years, and even the U.S., Europe and Japan
continued to ease monetary policy.
If the cry of "currency war" is a misdirection, what exactly is
it trying to distract our attention from? Many emerging market
countries want to have currency valuations that economists argue
are below fair value. They do so to promote exports and bypass
domestic structural obstacles to growth.
Under-valued currencies in and of themselves may attract foreign
capital flows, a nticipating currency appreciation. Moreover,
purposefully weak currency strategies often leave developing
countries more vulnerable to inflation, and more sensitive to the
monetary policies of other countries.
Currency Flexibility
The U.S., through numerous administrations, and in various
declarations of the Group of Seven industrial nations, has
consistently advocated greater currency flexibility. Such
flexibility would allow greater independence in the conduct of
monetary policy and offer greater insulation from external
developments.
This, of course, applies not only to Brazil, but also to China,
the world's second largest economy. A more flexible currency regime
would help officials refocus their economy from one driven by
external demand to one led by domestic consumption. It would allow
the Chinese people to enjoy a greater share of their country's
economic success and prowess.
Brazil's finance minister claimed that the U.S. was being
selfish in pursuing monetary policy without taking into account the
impact of such a policy on other countries. Yet, the real
selfishness and beggar-thy-neighbor policies are not the easing of
the U.S. and other advanced economies, but the reluctance of many
emerging countries to allow their currencies to appreciate in the
face of stronger growth, capital inflows and larger reserve
positions.
Monetary Policy
Even if there are costs for developing countries from the easy
monetary policy of the advanced economies, there are also benefits.
Part of the reason why the economies of many developing countries
have slowed is that their exports to the U.S. and Europe have
decreased as those economies have decelerated.
Easier monetary policy, which has taken on an unorthodox
characteristic given that policy rates are near zero, is meant to
help fuel a recovery in aggregate demand. Stronger U.S. and
European growth would stimulate trade as well as underpin growth in
emerging markets.
Aggressive monetary policy in the face of weak domestic
economies is not the equivalent of a currency war. To the contrary,
the fact that some developing economies insist on having
under-valued currencies is more directly recognizable as shots in a
currency war. Such policies can be associated with costs, such as
greater sensitivity to inflation and limits on the independence of
their own monetary policies. There are various drivers of capital
flows to emerging markets, and those capital flows do not appear to
be correlated with U.S. or European monetary policies.
It is interesting to note that, for the better part of the past
four months, as the Federal Reserve signaled, and then pursued
QE3+, the European Central Bank announced its Outright Market
Transactions and the Bank of Japan expanded its asset purchase
program in both September and October, the Brazilian real has been
largely flat. The dollar has largely been confined to a
BRL2.00-BRL2.05 trading range, though has strengthened
recently.
Investors recognize that there are a number of emerging market
countries, such as Mexico, Poland, Turkey and South Africa, which
have embraced currency flexibility to a greater extent. They have
increased the capacity of their own capital markets to absorb
inflows as well as absorbing a greater part of their own domestic
savings.
U.S. Dollar and Chinese Renminbi
There is another dimension to debate about currency wars. Many
observers argue that the U.S. dollar is in an inexorable decline
and that it will be increasingly supplanted by the Chinese
renminbi. On the other hand, China itself is not above deflecting
criticism of its rigid currency regime by criticizing the
international monetary regime and the role of the dollar.
The internationalization of the Chinese renminbi has been more
bluster than substance. The role of the renminbi in the world
economy remains minor. The numerous swap lines that China arranged
with many developing countries, which captured the imagination of
many critics of the U.S., have not been used. Few countries have
chosen to add the renminbi to their reserves.
The Dim Sum market, the offshore renminbi market in Hong Kong, a
special administrative region of China, is dominated by Chinese
state-owned companies, banks and property companies. Renminbi in
Hong Kong is not fungible with renminbi onshore. The currency
requires special authority to be used within China itself. Outside
of Chinese trade with Hong Kong, most of Chinese trade continues to
be conducted in U.S. dollars.
There has been some diversification of reserves away from the
dollar and euro in recent years. However, it has not gone to the
Chinese renminbi, but to the Australian and Canadian dollars. The
kind of transparency and flexibility that an international currency
requires still seems beyond the ken of Chinese officials.
More Rhetoric than Politics
Currency wars then, in either expression, seem to be more in the
realm of rhetoric than politics. There has been a long and
sustained push from the developed countries to get emerging markets
to embrace more flexible currency regimes. The adoption of
unorthodox monetary policy by the U.S., Europe and Japan may, on
the margins, increase such pressure but few have capitulated.
Instead, they have developed a host of other tools, such as
macro-prudential policies, to blunt the impact. China may one day
provide the world's key currency, but that day is not in sight, and
the role of the dollar as the numéraire continues.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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