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Perils of protectionism

FINANCE Minister Pravin Gordhan warned on Tuesday that the so-called currency wars could lead to "trade wars", if they were allowed to continue. From devaluing currencies, countries could proceed to putting up trade barriers.

What Gordhan is warning about is still a long way off, but it's common cause that protectionism – putting up of trade barriers – prolonged and deepened the Great Depression.

Though still a long way off, the US House of Representatives has taken the first steps towards allowing the US to slap duties on Chinese imports if that country is branded a currency manipulator.

There's currently a "race to the bottom" in the currency markets, with everyone trying to export their way out of sluggish growth. The only way out of this currency market chase would seem to be a multilateral solution, one crafted by the G20.

That's what makes this weekend’s meeting of G20 finance ministers and central bankers so important.

It's a precursor to a summit of G20 leaders in South Korea in mid-November, and the officials from these important countries could this weekend try to do what they failed to achieve at the International Monetary Fund (IMF) meetings – cobble together the draft of an agreement on currencies that would lead to an eventual accord to stop what has become a very dangerous game.

Rand Merchant Bank (RMB) says there are two global currency problems: firstly, unhappiness at the level of the Chinese yuan.

This has been most evident in the US, where the administration's rhetroic is becoming more critical and where congress is getting closer to passing a bill allowing US companies to request tariffs on imports unfairly helped by the undervalued yuan.

Spectacularly unsuccessful strategies

Secondly, there is unhappiness in many countries, including SA, over currency strength (essentially against the dollar, the euro and the pound). The cause here is weakness in those countries, fiscal problems but above all easy monetary conditons in the core economies that have led to capital flows to other countries.

"Many have responded by unilaterally trying to stop their own currencies from appreciating: Switzerland, Japan and Brazil are the most prominent examples. These actions have been spectacularly unsuccessful," RMB says.

RMB says a global problem suggests a global solution. Historically, the G7 nations took control of such matters. The major examples are the Plaza Aaccord of 1985 to weaken the US dollar against the Japanese yen and the Deutsche Mark, and the Louvre Accord of 1987 to stabilise the dollar.

In the modern world, the G20 summit is now the place for any agreement.

RMB says the outlines of such an agreement are pretty clear: China would have to agree to accelerate yuan gains. Current account surplus economies, above all Germany and China, would need to stimulate domestic demand. The major economies would say they support a strong dollar and agree to coordinate stimulus policies more closely.

RMB says this is all going to be difficult to achieve. China insists that the global curency problem is a weak dollar caused by excessive US monetary stimulus. It has been trying – with only partial success – to stimulate domestic demand for years. Germany views its fiscal and savings stance as something that should be admired, rather than a global problem.

The US also takes a hands-off approach to the dollar, having last intervened in the market in the 1980s. Given US economic weakness, policy makers certainly aren't going to agree to hold back fresh stimulus. And, not least of all, US officials might be quite happy with US dollar weakness (and eurozone officials with euro weakness, etc).

Ease off on monetary easing, please

Even if we did see coordinated global action, this wouldn't necessarily stem rand gains, RMB says, because it's hard to see how you could change the fundamentals of robust growth and high-yielding emerging market currencies against stagnant growth, zero-rate core markets.

RMB doesn't say this, but I believe if the US could be prevailed upon to hold back on another round of monetary easing ("printing money" by buying US government bonds), the dollar would bounce off its lows. True, interest rates in the US are still close to zero compared with 6% in SA, but further easing in the US has been priced in. If America decides not to go that route, the dollar would pull back from its weakest levels, saving the rand from further strengthening.

Metropolitan Asset Managers (MetAm) said this week that if advanced nations continued to address their problems with the wrong measures such as expanding liquidity, the rand could continually strengthen and break below the R6/$ level in 2011.

MetAm economist Ilke Smit said that for years leading up to the global recession many countries had lived beyond their means, causing global imbalances as shown in large current account deficits in advanced economies and corresponding surpluses in emerging economies.

In attempts to avert the rebalancing of these imbalances, advanced countries are trying to pass the parcel to developing markets by debasing their own currencies.

MetAm doesn't join in the debate about a multilateral solution, but I believe the only way to go is for the G20 to stop the US from further monetary easing. The point needs to be made that the monetary easing won't work to get lending going as long as banks are sitting on toxic assets.

May the G20 meetings this weekend and next month be more successful in ending the currency wars than the IMF meeting was. Gordhan, as a G20 finance minister, has his work cut out for him.    

 - Fin24  

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