EEF blog

In the G20 meeting in Seoul last week one of the key issues was how to avoid the currency wars which threatening global economic recovery. Although some agreement was made over continuing discussions, tensions have not dissapated. On Monday 15th November at 3pm EEF is hosting a twitter debate on the impact of currency wars on the UK, and UK companies. 

As a background to this, here are some key articles and blogs that have been written on currency wars in the last couple of months:

What is a currency war?

The BBC’s animated guide: http://ow.ly/388kiOr, if you’d prefer something to read, Stephanie Flanders’ summary is here: http://ow.ly/38bb7

When did this one start?

The first rumblings of currency hostility started in March 2010 when 130 bipartisan US Congressmen sent a letter last week to US Secretary of Commerce Gary Locke, calling for the government to identify China as a currency manipulator. However, it was Guido Mantega, Brazil’s finance minister, whose announcement on September the 28th branded competitive depreciations as “currency wars”. Reported by the FT: http://ow.ly/38bp8

Who is fighting whom?

The BBC’s Andrew Walker sets out the key players and the main battlegrounds: http://ow.ly/388oq What impact could currency wars have on the global economy?Competitive depreciation could represent a very serious risk to the global recovery. In particular, the global rebalancing which debtor countries are relying on to boost growth could be hindered by surplus countries accumulating excess reserves to boost their own exports. The FT reported here: http://ow.ly/38bOK

What has happened with currency wars in the past?

Douglas Irwin at the Wall Street Journal summarises how high tariffs and currency wars caused problems in the 1930s: http://ow.ly/38bxy

What happened at the G20?

According to the Guardian "the summit set vague "indicative guidelines" to measure imbalances" however "the leaders were unable to agree on how to identify when global imbalances pose a threat to economic stability, merely committing themselves to a discussion of a range of indicators in first half of 2011": http://ow.ly/39MMK  

Therefore, questions remain: What would trade wars mean for the UK? Crucially, how will UK companies be affected if exchange rates become increasingly volatile, or if currency tensions lead to increased protectionism?

Join the debate! On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars. The debate will start at 3pm and last for 45 minutes. 

Brian Cronin via Wall Street Journal

Writing in the Wall Street Journal, Douglas Irwin (an Economics Professor at Dartmouth College) looks at what history can teach us about how currency wars tend to escalate into trade protectionism:

"...[I]f some countries intervene unilaterally—as China is rightly accused of doing, with other countries appearing to follow suit—nominal exchange rates are affected; goods priced in Chinese yuan become cheaper when purchased with dollars or euros. The experience of the 1930s shows that this sort of situation breeds trade disputes and can trigger a protectionist response."

But he notes that a currency war doesn't have to lead to a trade war. For example, during the Great Depression, countries that left the gold standard were able to grow their economy through expansionary monetary policy, boosting growth. Others stuck to the standard and had no other economic policy tool but protectionism. Irwin says:

"Had it been coordinated so that exchange rates did not change abruptly, protectionism could have been kept at bay."

So coordination on exchange rates will help keep concerns on currencies from becoming trade tensions.

But even if all the world powers struggle to agree on coordination (as appears to be the case from this weekends meetings at the IMF), then Irwin say that expanding monetary policy can be an effective means of combating others manipulations:

"If all major central banks were to intervene on foreign exchange markets to drive down the value of their own currencies, none would succeed in changing nominal exchange rates, but it would be equivalent to a world-wide easing of monetary policy....If [growth meant] fears of deflation were to subside and employment were to expand more rapidly, the pressure for a protectionist response from Washington would dissipate. When the economy is performing well, currency disputes become background noise."

This may be part of the reason the US Fed is looking at more quantitative easing.

What does this mean for the UK economy? Well, the simple implication is that if coordination fails, looser monetary policy might help buffer our economy from any global economic turbulence.

Whether that fits with the Bank's inflation target is a question for another day.

As Brazilian finance minister Guido Mantega pointed out last week, and we noted here, 'currency wars' - where countries compete to deprecitate their currencies - are a risk to the recovery.

Today the FT reported that the head of the IMF, Dominique Strauss-Kahn has warned that competitive depreciation would represent a very serious risk to the global recovery. In particular, the global rebalancing which debtor countries are relying on to boost growth, will be hindered by surplus countries accumulating excess reserves to boost their own exports.

This week Brazil’s finance minister Guido Montega stated that an “international currency war” had broken out, as several governments have sought to increase the competitiveness of their exports by lowering exchange rates. A currency devaluation is traditionally thought to improve a country’s balance of trade by reducing the price of exports and increasing the price of imports. Consequently competition to reduce the value of currencies is damaging for those countries that don’t engage in the practice.

The Brazilian finance minister’s comments come at a time when the relationship between the US and China has become particularly strained by this particular issue. The US Congress has passed a bill defining China as a ‘currency manipulator’ and this could lead to new tariffs against imports from China. The Chinese, for their part, claim that allowing the renminbi to appreciate by the 20% Washington has requested would bankrupt the country’s exporters.

But it is not just China that has been trying to maintain an export advantage through keeping its currency at a competitive rate compared with the dollar. A rising number of countries see a weaker exchange rate as a way to lift their economies. There have been a series of recent interventions for example by South Korea and Taiwan. This month Japan intervened in foreign exchange markets for the first time in six years, selling around $20 billion worth of yen.

But this kind of exchange rate competition is unlikely to support global economic growth. Over the longer term currency intervention may be worse for the economies concerned. Devaluing a currency improves competitiveness artificially and reduces incentives for actions by governments or businesses that could boost productivity and output.

It will be difficult for the global rebalancing that debtor countries need to see to happen while surplus countries are accumulating excess reserves to shore up their own exports.

Last week we gave you a peak at what's keeping EEF's economist up at night and promised to go into more detail.

Well, one of the points was on global trade. Because although China is growing at around 8% (and potentially better), it's growth may be built on a shaky asset bubble, as the clever economists at RBS point out:

"The Chinese may be asking “What global slump?”...but the data are patchy and growth is probably being driven by government spending and investment in residential property. Lending regulations that were relaxed in response to the global slowdown have resulted in rapid credit growth...and much of the rise seems to have been used to fund speculation in equities and property. Consumer spending is flat, while trade and investment are down sharply. This sounds like a recipe for an asset price bubble rather than long-term growth."

What's just as worrying is that the growth within the China might be contained in China, as Beijing has introduced "Buy China" provisions:

"Protectionism has become a growth industry...of the Group of 20 nations, 17 countries have implemented some type of trade protectionism since pledging in November not to do so...China [is] the latest to embrace a "buy local" platform. Beijing has introduced an explicit "Buy China" policy that requires government procurement to be focused on Chinese products or services unless they are not available in the country or cannot be bought at a reasonable price.

What's more, the latest edicts from Beijing are notably worrying since they emanate from one of the strongest economies in the world. If China - with an economy expanding at an annual rate of roughly 7 per cent - feels the need to opt for blatant protectionism to mollify worker discontent, think of the mounting pressures on states whose economies have sunk deep into recession."

So basically the only country that's managed to recover from the global recession has done so through protectionism and speculation.

Now you know why we're worried.

The US, EU and China are embroiled in a dangerous game of chicken.

Not only are "Buy American" and "Buy Chinese" provisions proliferating, but the countries have lodged official complaints with WTO over trade in raw materials, computers and (yes) poultry.

These might seem like small issues, but the more cases that are brought before the WTO, the greater the danger a protectionist sentiment will proliferate across the major economies.

International trade has already fallen off the map as a result of the recession. And while the temptation of protectionism is tangible, these tit for tat measures on trade are souring relations between the countries.

But neither should an economy be allowed to take a 'beggar-thy-neighbour' response to their economic woes.

That's a fine line to walk, but hopefully we can avoid a full blown trade war.

Missed this yesterday (and apologies for the awful headline pun), but the European Competition Commissioner, Neelie Kroes, has made an interesting speech in defence of the Single Market during the recession and beyond.

In short she made three, very important, points:

1. We can't solve our economics problem by resorting to 'beggar thy neighbour' protectionist strategies

2. We still need to take measures to repair the financial system

3. Competitive markets will make the recovery easier so the Commission is not going to go soft on competition.

This is good to hear, especially as the EU has real teeth when it comes to state aid and competition policy, but whether the Commission still has the political will to get tough with Member States is open to question.  

A lot could depend on the make-up of the next Commission, which should take office later this year (although there could be a delay as a result of constitutional shenanigans if the Irish reject the Lisbon Treaty before then). 

The current set of Commissioners have been far more 'market friendly' than some of their predecessors (it has been the Commission for example that has taken on Member States in an effort to properly open up EU energy markets).  Whether this will be true of their successors remains to be seen.

As predicted on Friday, not much substance came from the meeting of G-20 finance ministers over the weekend.

The US pushed for more fiscal stimulus, especially from the Europeans. The Europeans said they had done enough, focusing instead on tougher financial regulation. The only common ground was increasing funding for the IMF, although emerging economies want greater voting power in the IMF. There was even a disagreement about grammar. The result was grammatically correct statement that commited the countries to "stand ready to do whatever was necessary for as long as it is necessary".

While it appears that meeting did not deliver in terms of substance, raising questions about the value and credibility of next month's summit, it never hurts to have the the largest economies having the debates and discussions they had this past weekend.

There is no silver bullet to the current crisis, but ongoing dialogue will help prevent a slide into protectionism. And that can only be a good thing.

Business Secretary Lord Mandelson and Skills Secretary John Denham have today announced their Departments will conduct a review of productivity and skills in the engineering construction sector.

This is undoubtedly a response to the wildcat strikes from earlier this month.

Brad Setser at the Council of Foreign Relations sees a truly global slump:

"China’s GDP growth stalled in the fourth quarter, which represents an enormous deceleration from its typical fast growth.

US GDP fell at a close to 4% annualized rate in the fourth quarter. The decline would have been steeper but for a big buildup in inventories. That will subtract from growth in q1.

Japanese GDP growth fell by around 10%. Some estimates are now even putting the q4 fall, annualized, at close to 12%. The fall in smaller Asian economies was often even larger.

And now we know that Europe’s GDP fell by 1.5% q/q, or 6% annualized. Germany, until recently Europe’s strongest economy, contracted at an 8% annual rate."

But while The Economist picks up some signs of life in China, it is troubled by the subtle protectionism building up in the US. Although 'Buy America' provisions grabbed the headlines last week, The Economist believes the 'Hire America' provisions passed by the Senate are potentially just as pernicious:

"the Senate's vote last week to restrict banks receiving TARP money from hiring workers on H1-B visas...is essentially “Buy America”, only applied to labour instead of physical capital. But in the long run, it could be far worse...the gains from human capital unfold over a longer period of time and skilled labour does not flow as readily...I can think of few other consistent means of growth than importing skilled labour. I can not imagine what the justification is for forcing economic growth to go elsewhere."

Here in the UK, British jobs are a hot-button political issue as well, as our own Steve Coventry wrote earlier this month:

"It is easy to say that we should give priority to British workers. But the free movement of labour is at the heart of EU law; undermine that and we run the risk of retaliation from other EU countries...In the long-run this would be a disaster for British business, workers and consumers. Protectionism doesn't work."

Given the global slump, protectionism is the quickest path to prolonging the pain and undermining long-term growth. Owen Tuder at the TUC understands the protectionist urges, but hopes that politicians will reject them as short-term palliatives with significant long-term costs:

"The reason people are prone to protectionism is that bad things are happening which will hurt people. And politicians are looking for ways of mitigating that pain, even if they can’t prevent it. That’s a good thing, not a bad thing. What we need is ways to mitigate the pain which don’t cause worse pain later on."

Protecting our long-term interests requires international coordiation and solutions that build on the benefits of open, globalised economies.