GLOBAL trade tensions are escalating. Last week the US House of Representatives passed legislation which, if also passed by the senate, would give the government the power to impose economic sanctions on China and other countries found to be "currency manipulators".
This is a strong warning to China that the US could take the unprecedented step of treating currency manipulation as an illegal subsidy for the purpose of calculating extra duties on Chinese imports as retaliation. The bill has to be passed by the US senate, but already commentators are warning about the dangers of starting a trade war with China.
But it's not just about China and the US any more. Last week, Brazilian Finance Minister Guido Mantega warned: "We are in the midst of an international currency war." Several countries, including Japan, South Korea, Brazil and Switzerland, have been intervening to hold their currencies down.
Jeremy Warner of the Daily Telegraph asks, rather dramatically: "Is this not the 1930s in redux, and therefore a threat to global stability more profound and imminent than any of the more usually identified hazards of international terrorism, nuclear profliferation and the scramble for scarce resources?"
Warner calls this a "game of beggar thy neighbour", in which the biggest sinner is reasonably identified as China. But, as he points out, America and Britain are engaged in much the same thing.
"Massive quantitative easing... has effectively created a negative interest rate and a debauched currency to boot. Already recriminations are running thick and fast," he says.
Quantitative easing is the jargon for printing money, which the US and the UK have done on a large scale by buying government bonds. In doing so, they pumped cash into the banking system in the hope that the banks would be pushed into lending the excess cash.
China's controlling waysThe US is getting increasingly unhappy about what it sees as the destruction of US jobs by cheap Chinese exports.
An interesting analysis of the situation comes from someone who isn't a believer in free trade. Ian Fletcher, a fellow at a US think tank, analyses the ways in which China manipulates its currency and how it might respond to action from the US.
He says China manipulates its currency by preventing its exporters from using the dollars they earn as they wish. Instead, they are required to swap them for domestic currency at China's central bank, which then "sterilises" the dollars by spending them on US Treasury securities rather than US goods.
As a result, the price of the dollar is propped up – which means the yuan is pushed down – by demand for dollars which doesn't involve buying US exports.
As a means to retaliate, China could threaten to stop buying US Treasury debt, says Fletcher. "But it is constrained by the fact that this would reduce the value of the $840bn or so that it already holds. The action would also lower the price of the dollar by abandoning China's key lever for pushing it up."
However, the point Fletcher misses is that if the US bill becomes law, China will have fewer dollars anyway to buy US treasuries as it will be exporting less to the US. The question that arises is who will then buy the treasuries no longer bought by China?
Call for a new global currency pactOne answer is that other Asian countries, such as Vietnam, would take the place of China in the cheap export stakes and start behaving like China. But let's say the measure is somewhat successful, and US manufacturing responds to the duties on China by producing more for domestic consumption.
It would probably mean domestic US investors would have to invest more in treasuries, which means they would have to save more.
The US would import less, but the cost of goods would rise, and the country would have to save more. It's difficult to see the US consumer putting up with increased prices after getting so used to cheap Chinese imports.
It's also difficult to envisage US manufacturing taking up all the slack left as a result of Chinese imports not coming in, as the capacity to produce goods has shrunk as imports have expanded.
Fraser believes the US should take action against China now, or risk an explosion in its trade deficit that will, in time, lead to a massive and destabilising weakening of the dollar later.
Current dollar weakness won't destabilise the US economy, but countries such as Brazil would argue it's destabilising the world. Add to that the fact that the euro is also weak, and it's hardly surprising that there is talk of a currency war.
The Institute of International Finance, which represents more than 420 of the world's leading banks and finance houses, has called for a new currency pact to help rebalance the global economy.
The institute warned that the lack of such coordinated rebalancing could lead to more protectionism. It is right, but getting all the players to the table to agree on what action needs to be taken is an almost impossible task.
In the meantime, it's "beggar thy neighbour" in the currency markets.
- Fin24.com