Currency Wars

Sources:

Bloomberg: Geithner Says Japan Isn't to Blame for Global Currency Tension

M and C News: U.S.-China Tension Evident in Futile House Currency Bill

Money Morning: World Finance Ministers Aim to Quell Currency Tensions (1st Lead)

One of the basic fundamentals of economics is that devaluing currency will help economic growth. This works because of exchange rates. Lowering a country’s currency value lowers the price of its goods to foreign buyers, stimulating exports and thus the economy. Because of countries’ recent manipulation of their currencies, some fear that the world is entering a currency war.

In a currency war, each nation tries to keep its currency undervalued to increase its exports. Timothy Geithner, the United States Secretary of the Treasury, warned “that emerging powers were putting the global recovery at risk unless they showed more willingness to let their currencies rise.” By keeping currency values low, the developing nations limit their own citizen’s purchasing power of international good and limit the ability of developed nations to export. This is because currency devaluation acts like a tariff against goods from developed nations, making those goods more expensive to consumers than they would be without manipulation.

Currency tension is the major subject at the upcoming G-20 meeting in October, 2010, and of the meeting of the world finance ministers at the IMF on October 8^th. While Mr. Geithner did not mention China specifically, China is the main target of Mr. Geithner’s accusation of currency devaluation. The Canadian Finance Minister added that it was up to China to let its currency rise if other countries are going to let theirs rise. The IMF managing director and president of the European Central Bank both issued statements urging currencies to reflect economic fundaments to avoid a currency war.

Getting China to change will be challenging because some nations are less willing to pressure China. China is by far the largest developing power and some developing powers will follow China’s lead. Brazil will not confront China at the G-20 because China is a major importer of Brazilian goods. Furthermore, many developing Asian nations are resistant to force China to change because they see Chinese success as something they can latch onto, catching a free ride to the developed world.

However, the United States does not feel all current currency devaluation is hurting the world economy. Japan recently devalued its currency, but because the economic recovery is slow in the United States and Europe is saddled with public debt, many investors view Japan as the safest place to store their money in the developed world. Mr. Geithner actually said that the Japanese Central Bank’s intervention in the currency market on September 15^th to lower the value of the yen was a justifiable act.

Congress has placed significant pressure on China and President Obama to deal with the currency devaluation issues by passing The Currency Reform for Fair Trade Act in the House of Representatives. Although it recommends punishments for countries that undervalue their currencies, it will not have any practical effect because the punishments listed are illegal according to WTO laws. However, the bill does specifically mention the Chinese yuan, an important political statement regarding the Chinese government.

Congress is not alone in feeling wary of China’s economic power. Robert Samuelson, the contributing editor of the Washington Post, gave a stark warning. He said the U.S. had a choice to resist Chinese ambitions and risk a trade war, or do nothing and set a precedent that the basic rules of the world economy and free trade are optional, adding, “The first would be dangerous; the second, potentially disastrous." The United States may have options, but neither of these sound good in the long run.

Discussion Questions:

1. Is there a moral argument that the United States should yield an economic advantage to developing countries to help them develop more quickly?

2. Brazil has a trade surplus with China and the United States has a trade deficit. Why such a divergent trading pattern?

3. Is China’s currency manipulation likely to be effective in the long run, or will it simply make Chinese industry unfit for global competition if the yuan is allowed to be properly valued?

4. Why is the United States Congress becoming so involved with currency disputes, and how could the November elections be affecting Congress’s involvement?