The Great Debate

Euro zone faces QE2 pain test

James Saft

Oct 14, 2010 09:23 EDT

QE2 — a second round of quantitative easing — means that soon the U.S., Japan and Britain will all be busily exporting their deflation, raising the question: Just how much pain can the euro zone take?

If by November we have three of the largest economies printing money and buying up their own debt, the outcome — in fact the intention — will be to drive their currencies lower against their trading partners, opening new international markets for their goods and, by raising the price of imported goods, fighting deflation before its debilitating psychology can take hold.

That is the plan, at any rate, and, unless something else happens, it will force the euro up against all major currencies, including, as it is tied to the dollar, the Chinese yuan. The euro has risen about 9.5 percent against the dollar in the past month, a trend that ultimately will murder European exporters and its stock market.

For reasons of history, society and sheer cussedness, the European Central Bank does not seem inclined to join in, though as usual there is dissension.

Speaking in New York on Tuesday ECB President Jean-Claude Trichet said that the ECB’s own version of QE, buying bonds of euro zone weak links and other liquidity support, will continue as planned at least until the end of the year, at which point, “We will see.” In contrast governing council member Axel Weber, speaking in the same city on the same day, pointedly called for an end to special measures immediately, saying the risks do not justify the benefits.

Forcing Europe to absorb more of the global deflation is really nothing more than a “back at ya” by the U.S. and others. Europe, in deciding to cling to its currency union and impose austerity on its weaker members, was doing exactly the same thing; exporting deflation, both in terms of a weaker euro and through the desperate actions of Greek and Irish residents who will consume less and must export more.

So, why won’t Europe simply power up its own printing presses and join the currency debasing party? In part it is a matter of history; the old Bundesbank horror, bred in the bone, of the inflation that devastated Weimar Germany.

China runs circles round adversaries

J Saft

Oct 5, 2010 07:26 EDT

If the global currency war was a baseball game, they would have to invoke the “slaughter rule” and send China home the winner.

Motivations and consequences aside, China is so adroit in melding diplomacy, jawboning and action to keep the value of its currency low that you have to feel something approaching compassion for its plodding adversaries from the U.S., Europe and Japan.

China’s latest well played move is its pledge to use some of its massive foreign currency reserves to support poor Greece, which the markets widely believe will default some fine day, European Union support or not.

“With its foreign exchange reserve, China has already bought and is holding Greek bonds and will keep a positive stance in participating and buying bonds that Greece will issue,” Chinese premier Wen Jiabao said in Athens on Saturday.

“China will undertake a great effort to support euro zone countries and Greece to overcome the crisis.”

While China does have an interest in global economic stability, especially stability in currency regimes, this was not a move primarily motivated by a regard for European solidarity or even the principle that cheaters deserve a second chance.

Lombard Street Research economist Gabriel Stein nailed this in a note to clients:

China hits a welcome turning point

James Saft

Jun 17, 2010 08:16 EDT

China’s massive supply of cheap labor may at last be drying up, a development that in time will bring higher wages, inflation, a stronger yuan and help to right dangerous global imbalances.

If these trends hasten financial liberalisation they could eventually set the stage for a broader Chinese bubble. The formerly extremely unequal balance of power between workers and employers in China appears to be shifting.

Workers for a Chinese company which supplies Honda with auto parts have struck and successfully won large wage increases. Other strikes have followed, and firms have often been quick to compromise.

Hon Hai’s Foxconn, an electronics unit that supplies many leading western brands, moved to more than double many salaries as part of a series of reforms after a spate of suicides among workers at its highly regimented factories. Several regions have implemented or are debating increases to the minimum wage, a standard which didn’t even exist in China as recently as 2004.

Much of China’s economic development in the past 25 years has been built on the back, or backs if you like, of rural workers who were desperate to relocate to coastal manufacturing centers, wave upon wave of whom kept wages in check even as the economy boomed.

The one child policy and rapid development of the manufacturing base may finally be about to collide. A US Census Bureau analysis of Chinese data estimates that the number of 15-24 year olds joining the work force will fall by 29 percent over the next decade.

Euro woes increase risk of trade wars

J Saft

May 20, 2010 09:28 EDT

Europe won’t just be exporting deflation to the rest of the world, it will export serious trade tensions as well: first between the United States and China, and, possibly, eventually between Europe and the United States.

The austerity required to get Greece and other weak euro zone nations’ budgets in shape will exert a powerful deflationary force, as many countries which formerly imported more than they exported will be forced to cut back.

As well, the euro has dropped very sharply. Germany’s quixotic campaign against speculators — banning naked short selling against government debt and government credit default swaps — gave the euro its latest shove downward, but the trend has been strong for months. The euro is now about 15 percent below where it started the year against the dollar, making U.S. exports less competitive and adding to pressure on the United States to be the world’s foie gras goose: being force-fed everyone else’s exports while its own unemployment rate remains high.

That Britain is now embarking on its own round of budget cuts will only make matters worse, adding up to one more important actor trying to consume less and export more courtesy of a devaluing currency.

Perhaps the best outcome is rising trade and currency tensions between the United States and China, while at worst this could set the stage for broader conflicts and a round of tit-for-tat tariffs to match similar currency devaluations.

Michael Pettis, a professor at Peking University, explains the issue succinctly on his blog, in which he says: “Make no mistake, if southern European trade deficits decline, someone somewhere must bear the brunt of the corresponding adjustment. The only question is who?”

The scale of the adjustment is large; taken together Spain, Italy, Portugal and Greece account for about 16 percent of global trade deficits. Add in France, which will surely share some of the pain, and we get up to about 20 percent. You simply cannot have savage recessions and budget cutbacks in these countries without it exerting a powerful force on their trade partners.

Be careful what you wish for on currencies

John Kemp

Mar 19, 2010 08:41 EDT

The rancorous argument about global payment imbalances and the yuan’s valuation is exposing a surprising and dangerous economic illiteracy among policymakers and commentators.

Before pressing China to allow a maxi-revaluation of the yuan, western commentators need to think through the consequences carefully. The idea that devaluing the dollar (and by extension euro and yen) will cause payment imbalances to disappear and boost employment in the West with little or no impact on inflation and living standards is a pipe dream.

MAXI-DEVALUATION First some notes about terminology. Proponents generally phrase their argument in terms of an appreciation of the yuan (which keeps the focus on the alleged currency manipulators in China). But it could just as easily be recast as a depreciation of the dollar (which is a much more controversial formulation, highlighting the fact that the exchange rate problem reflects U.S. weakness as much as China’s strength).

Since most observers assume bilateral relationships between the dollar and other major currencies would not alter significantly, China is in fact being pressed to permit a balanced depreciation of the dollar, euro, yen and other major currencies.

Finally, we are not talking about small changes but very large ones. Observers have suggested the dollar might be overvalued as much as 25-50 percent. Devaluing it 5 percent is unlikely to cause a substantial adjustment in China’s trade surpluses with the United States and globally and will not remove the political tensions and the root of the crisis. Only a very large reduction in the dollar’s value over a period of years, in effect a “maxi-devaluation”, could hope to adjust the relative trade performance of the two countries.

ADJUSTMENT WITHOUT INFLATION? Within the United States and euro zone, the main impact would be to raise the price of tradable goods and services relative to their non-tradable counterparts. Exports would become more competitive while imports would become significantly more expensive. Demand would switch from domestic consumption and imports towards exports and import-competing firms.

Normally, such expenditure-switching adjustments would need to be accompanied by expenditure-reducing tax hikes, spending cuts and interest rate increases to shrink non-tradable industries to expand export and free up resources for import-competing sectors, allowing adjustment without triggering inflation. The combination of expenditure switching and reducing policies is the standard prescription at the heart of an IMF structural adjustment programme in developing countries.

U.S. currency bill likely misses target

John Kemp

Mar 16, 2010 18:15 EDT

U.S. Senators Charles Schumer (D, New York) and Lindsey Graham (R, South Carolina) have announced plans to introduce a bill allowing the Commerce Department to take account of currency undervaluation when calculating anti-dumping duties.

The target is clearly China. It threatens to inflame the already rancorous and dangerously escalating dispute with Beijing over exchange rate policy to no good purpose. Legislative pressure will not make China’s government any more likely to accelerate the renminbi’s revaluation. If anything it will cause the government to postpone a revaluation most officials concede will eventually be necessary. China’s government cannot afford to show weakness in succumbing to pressure from “western devils” (“gwai lo”) without losing face in the eyes of its own public. China’s Premier Wen Jiabao has already branded U.S. pressure on the currency issue as a form of “protectionism.” The Schumer-Graham bill is likely to draw an even more angry response.

So the Schumer-Graham bill is a piece of election year theatre, but a counterproductive one. It threatens to worsen already poor relations between two countries that need to be friends but are currently experiencing a steady escalation in tensions on everything from economics to Tibet and weapons sales to Taiwan.

Trading insults is not going to bring the currency dispute any closer to resolution. The only constructive way forward is to take the issue out of the headlines, allowing China to appreciate the renminbi in its own time, prodded by a domestic inflation problem and the need to control inflows of hot money.

“CURRENCY MANIPULATION”

The U.S. Treasury Department is already required to analyze the exchange rate policies of foreign currencies and consider whether they manipulate their currencies to gain an unfair trade advantage, reporting the findings to Congress annually, under the terms of the 1988 Omnibus Trade and Competitiveness Act. The law also mandates separate six-monthly reviews of specific aspects of exchange rate and economic policy.

The 1988 law was passed the last time the United States was worried about the loss of manufacturing jobs overseas, at that time to Japan, through the alleged under-valuation of the yen. So there is nothing new in the use of legislation to tackle the perceived undervaluation of foreign currencies (or overvaluation of the dollar).

China’s yuan, not the dollar, is too cheap

– Peter Morici is a Professor at the Smith School of Business, University of Maryland, and former chief economist at the United States International Trade Commission. The views expressed are his own. —

From Berlin to Bangkok, governments are screaming about the falling dollar, because they can no longer rely on reckless American consumers to power their economies.

From the late 1980s to 2007, the global economy enjoyed The Great Moderation-low inflation and sustained growth interrupted by brief recessions. Driving global growth was an eight fold increase in the U.S. trade deficit, facilitated by a doubling of the value of the dollar against other currencies from 1989 to 2002.

Deregulation and new technologies powered U.S. growth, and Americans flush with success bought whatever the world had to sell. However, when imports substantially exceed exports, Americans must consume more than they earn producing good and services, or demand for what they make is inadequate, inventories pile up, and layoffs and recession follow.

From 2003 to 2007, the U.S. trade deficit averaged $665 billion, and Americans massively borrowed from abroad to keep the U.S. economy going. They posted as collateral overvalued homes financed on shaky mortgages. When mortgages failed, banks failed, home prices dropped, and retail sales tanked. The U.S. economy was thrust into the worst recession in 70 years and pulled the rest of the world into crisis.

Imports of oil and consumer goods from China account for the lion share of the U.S. trade deficit. Americans drive big cars powered by thirsty engines. They sit on vast untapped deposits of natural gas but burn too much heating oil in the winter. Simply, conservatives in Congress are unwilling to submit to genuine energy conservation, and liberals teach developing domestic fossil fuels resources is evil.

For nearly two decades, China has maintained an undervalued currency. The Chinese government tightly regulates private trading in the yuan, and each year, purchases more than 400 billion U.S. dollars with newly printed currency to keep the yuan artificially cheap against the dollar. That is 10 percent of China’s GDP and 20 percent of exports to make Chinese goods artificially inexpensive on U.S. store shelves and juice Chinese exports.

Global rebalancing to weaken dollar, quietly

Neal Kimberley

Sep 24, 2009 12:10 EDT

– Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own –

Twenty-four years ago, major nations called for depreciation of the dollar to rebalance the global economy. Now, as another effort at rebalancing looms, the dollar will again bear the brunt — though officials will try to ensure its fall is less dramatic this time.

That’s the implication of President Barack Obama’s announcement this week that he will push world leaders for a new global “framework” in which the United States would cut its huge trade and budget deficits.

Agreeing on this framework would be politically difficult, since it would require policy changes by many countries — China, for example, would probably have to rein in its explosive export-led growth.

But as the euro’s climb to a new one-year high versus the dollar this morning shows, markets are starting to think the rebalancing process may start as soon as this week’s Pittsburgh summit of leaders from the Group of 20 nations.

The Plaza Accord of 1985 called for “orderly appreciation of the main non-dollar currencies against the dollar”; it was followed by central banks’ coordinated intervention to ensure that happened.

This time, with the world shakily emerging from a financial crisis, policymakers are likely to try to manage the dollar’s drop in a more low-key fashion.

Yuan trade settlement mission impossible, for now

– Wei Gu is a Reuters columnist. The opinions expressed are her own —

The People’s Bank of China’s ambitious plan to settle foreign trades in yuan has been given the cold shoulder by companies both at home and abroad. The failure of this experiment shows the difficulties China faces in internationalising its currency.

Launched by the PBOC with a fanfare almost two months ago, the pilot scheme has so far seen only thin volumes of yuan trade settlement. Guangdong province, the country’s export hub, was supposed to be the cornerstone of the plan, but local officials said they found few willing counterparties.

This should not have come as a surprise. Foreign importers either have little access to the yuan, are reluctant to part with it, or do not want to commit future payment in a currency that is expected to appreciate. More surprisingly, domestic exporters, who would benefit from lower currency risks, are put off by the logistical headache of receiving domestic currency for their exports.

These concerns aside, there is a more fundamental reason why the yuan is not catching on. The Triffin Dilemma, named after the Belgian-American economist who rose to prominence in the 1960s, stipulates that it is hard for a country running a large trade surplus to demand that others buy goods using its own currency.

The world now suffers from an oversupply of the manufactured goods that are China’s specialty. Thus it is hard for China’s millions of small exporters to demand that Wal-Mart pays them in yuan, or for thousands of small Chinese steel mills to persuade Rio Tinto and BHP Billiton to accept the Chinese currency.

Only exporters in countries such as Indonesia, which has a limited amount of foreign reserves, have an incentive to sell goods such as timber to China in exchange for yuan, which can be used to buy imports from China later. But given the lack of convertibility of the yuan, it is probably not worth going through the hassle.

Getting ready for the dollar’s fall

Agnes Crane

Aug 20, 2009 07:37 EDT

It just won’t go away, this needling worry about the U.S. dollar losing its coveted top-dog status.

No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.

Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to the world.

Much of the debate so far this year has centered on creating an alternative to the U.S. dollar, championed by China and Russia as a way to wean the world off its dependence on the U.S. as well as buffer individual nations against the missteps of those in developed world. Most recognize creating a new currency will take years and the chances of an existing currency, like the yuan, usurping the dollar anytime soon are remote.

But that doesn’t mean big money isn’t starting to prepare for world in which the buck isn’t the currency of choice.

Curtis Mewbourne, a portfolio manager at PIMCO, has suggested that investors diversify away from the dollar and to move into other currencies, especially those in emerging markets.

“And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” he wrote in an article published on PIMCO’s website.