Shots Fired
Posted: November 4, 2010 Filed under: Global Financial Crisis | Tags: currency devaluation, quantitative easing, U.S. Economy, US China Trade 42 Comments
I figured I better start a series of posts on the frontiers of our third war. You probably won’t be thrilled to hear that the General in charge of the theater is none other than Timothy Geithner. The other general in the war is Ben Bernanke. Feeling any better year?
Well, ready or not, we may be in the very first strategic moves set out to wage a currency war and possibly a trade war. The two superpowers in the battle are China and the U.S. who seem to be in a fight to see whose currency can go the lowest. Paul Krugman has written about this quite abit. Naked Capitalism actually had a superb guest post on the topic today. The Economist front paged the entire topic in mid October.
I’ll quote from one of The Economist’s major articles here.
Behind all the smoke and fury, there are in fact three battles. The biggest one is over China’s unwillingness to allow the yuan to rise more quickly. American and European officials have sounded tougher about the “damaging dynamic” caused by China’s undervalued currency. Last month the House of Representatives passed a law allowing firms to seek tariff protection against countries with undervalued currencies, with a huge bipartisan majority. China’s “unfair” trade practices have become a hot topic in the mid-term elections.
A second flashpoint is the rich world’s monetary policy, particularly the prospect that central banks may soon restart printing money to buy government bonds. The dollar has fallen as financial markets expect the Federal Reserve to act fastest and most boldly. The euro has soared as officials at the European Central Bank show least enthusiasm for such a shift. In China’s eyes (and, sotto voce, those of many other emerging-market governments), quantitative easing creates a gross distortion in the world economy as investors rush elsewhere, especially into emerging economies, in search of higher yields.
A third area of contention comes from how the developing countries respond to these capital flows. Rather than let their exchange rates soar, many governments have intervened to buy foreign currency, or imposed taxes on foreign capital inflows. Brazil recently doubled a tax on foreign purchases of its domestic debt. This week Thailand announced a new 15% withholding tax for foreign investors in its bonds.
Currencies are actually my research area and I’m preparing for a series of papers and presentations on the ASEAN+3 area and the GCC area. China is one of the +3. The U.S. dollar is the peg for the GCC because of the influence of Saudi Arabia. Every one has a stake in this including the European Union. Anyway, let’s just say this is part of my thing and it’s a complex thing so I’m going to do a series of short posts on this to get every one more or less situated.
This is a quick introduction because I’m going to have to start with what’s happening tomorrow. This situation is likely to be on the meeting table for APEC Forum starting tomorrow in Japan. ( That’s the Asian-Pacific Economic Cooperative.) Geithner’s trying to get the region to shrink their current account imbalances with the U.S. The current accounts are the accounting mechanisms for an open economy that deal with foreign trade. They are bookkeeping entities where trade payments from exports and imports for goods and services as well as a few other things like any incomes made by citizens who work or invest in other countries are tallied. The things that most international economists are interested in are the flows of imports and exports (the stuff and services) and the flows of capital (money, plant and equipment for businesses) between countries. Of course, all this exchange and investing happens with the currency of the country. It is the country’s medium of exchange.
As you know, the United States is the biggest customer in the world and we buy a lot of things from other countries. That means we need their currencies to transact business there. This also means the amount of their money floating around the world and the amount of our money floating around the world is important for trading or exchange of goods and services. It’s also important because if you don’t buy, you invest, and if you invest, your currency goes into a financial market and earns interest. If that doesn’t happen you sell the currency for another one at the going exchange rate. The market for currencies also influences the levels of interest rates in the world among a few other things. And, of course, the keepers of the currency–the Central Banks of a country are involved–hence our FED. So, Bernanke watches exchange rates, amount of money floating around and interest rates while Tim Geithner’s folks set up terms of trade between countries. Terms of trade can include free, open markets or things like tariffs, quotas, and capital controls. These things get set up in trade treaties and are usually negotiated frequently. All of this stuff determines whether a country will outsource your job some place else and will fund a business someplace else instead of your town. It also determines what you can buy at your favorite store.
Geithner aims to use a Nov. 5-6 meeting of Asia-Pacific Economic Cooperation forum counterparts in Kyoto, Japan, to press his case for current-account deficit or surplus targets of less than 4 percent of gross domestic product. The proposal is also on the agenda for a Group of 20 summit in Seoul next week.
The U.S. has cited a glut of Asian savings for helping spark the credit crisis earlier this decade, while Asian officials now counter it’s the American central bank’s liquidity injections that are warping global capital flows. Geithner’s initiative is undermined by complexity in calibrating current accounts and a failure of similar efforts in the past.
“We have the outline routine of an impressive-looking agreement that literally changes nothing,” said Steven Englander, Citigroup’s head of Group of 10 currency strategy in New York. “Nevertheless in the short term investors are likely to be more impressed by the indications that U.S. and China are reconciled than by the underlying content of the reconciliation.”
Geithner’s plan was in part designed to broaden discussions beyond China’s exchange-rate policy, blamed by U.S. lawmakers and companies for keeping the yuan artificially low in a subsidy for local exporters. China may be open to the idea, a central bank adviser indicated last week.
And, what’s up with Brazil, the country that fired the opening salvo in this edition of Currency Wars? Well, according to that link at the FT, it seems that the word is not happy with Timothy Geithner.
Brazilian officials from the president down have slammed the Federal Reserve’s decision to depress US interest rates by buying billions of dollars of government bonds, warning that it could lead to retaliatory measures.
“It’s no use throwing dollars out of a helicopter,” Guido Mantega, the finance minister, said on Thursday. “The only result is to devalue the dollar to achieve greater competitiveness on international markets.”
At a joint press conference with president-elect Dilma Rousseff, outgoing president Luiz Inácio Lula da Silva said on Wednesday he would travel to the G20 summit in Seoul with Ms Rousseff, ready to take “all the necessary measures to not allow our currency to become overvalued” and to “fight for Brazil’s interests”. “They’ll have to face two of us this time!” he said.
Brazil and others are not happy with the Quantitative Easing 2 we talked about earlier today. This is because it’s an attempt to stimulate the economy and it will cause there to be more dollars floating around the world. Any one with a first semester class in economics should know that an increased supply means falling prices. The price of money is on one hand, interest rates and in the open economy, it is also the exchange rate. This means that U.S. goods will become cheap and every one else’s will look relatively more expensive. U.S. folks should import less and be able to sell more abroad as exports. If you’re trying to grow your economy on the back of the U.S. consumer’s appetite for stuff, that will now be more difficult.
Okay, so I’m reaching MABlue’s limit for me blathering on too long. The links I gave you are pretty wonky and long. I just wanted to bring up the topic and get you up to speed because this is THE NEXT big THING. I’m going to try to keep up with what’s going on with the meeting and let you know more about the topic.
If all else fails, you can consider this a way to your good night’s sleep.
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I’ve never really understood how the Euro fits into all this. All other countries that control their own currencies can play beggar thy neighbor at will (assuming they decide to play fast and loose with their international treaties), but if the Euro countries wanted to devalue the Euro, what would they have to do?
As an aside, my best friend’s son has been traveling frequently to China on business–mostly to the interior of the country, not the glitzy coastal cities. He says the poverty in China, outside of Beijing, is devastating. It’s no wonder the Chinese are fighting any adjustment in their currency. For all the millions of jobs they’ve assumed from former U.S. workers, they still have millions more who are destitute.
and that’s an equation for civil unrest. I’m posting on the connection to the Euro a bit tomorrow. The Swiss franc is already going through devaluation and the EU is expecting to follow through with QE also. Britain also. It could be a race to the bottom.
Fascinating. I have a feeling this is going to get ugly.
yeah, which is why the meetings in Japan should be interesting. The Brazilian minister is sure to get the South American bloc stirred up too. VERY interesting.
This is interesting, I have a question…what is Russia’s take on all this? And do you think the recent “fuss” about the Kurile Islands between Russia and Japan (and I believe China is getting involved in too) have anything to do with this Economic Summit? It seems this dispute over these Islands is something that has been going on for a long time. It just seems odd that a heated exchange would start up again right before this meeting.
Sorry, not economic summit…I mean the APEC Forum.
Russia has a lot of oil and minerals and their economy is developing. They’ve got attachments all over the place. They’re staying out of it so far. This will probably be a big topic in the g-8, g-20 meetings. The Russians are in the g-8. They’ve called for a cease fire to date.
http://in.reuters.com/article/idINIndia-52164420101013
oh, russia’s claiming those islands of Japan and most of their activity seems to be surrounding that issue at the moment
Yes, sorry…here is some info on that:
http://www.voanews.com/english/news/China-Rejects-US-Mediation-in-Territorial-Dispute-With-Japan-106508383.html
http://www.radioaustralia.net.au/connectasia/stories/201011/s3058162.htm
you can sneak a look at the link, you know …
I did read the Geithner-APEC article, and, of course, I read the article on Naked Capitalism this morning (pretty good, I thought). But I couldn’t get through the FT firewall. I set up a free account there some time ago, and even though they said that it took, it refused to recognize future log-ins, so I gave up trying.
yeah, the WSJ and the FT want you to PAY a lot
grayslady, you can copy part of the quote from ft (or articles from any other site that won’t let you read for free), put it between quotes and then google. That will provide you with multiple choices for free reading.
?
The price of money depends on how much of it is out there and how much stuff is out there to buy.
Won’t it hurt our economy, or at least our savings accounts, to further devalue the dollar with the falling prices? Maybe it doesn’t matter because Americans can’t/won’t buy enough anyway, foreign or domestic made?
It hurts some people and helps others. It won’t help folks that want to buy things made in other countries because those things will get more expensive, for one.
I can see why they do it then. I’m really a neophyte at this level of economic understanding, so pardon my ignorance.
I do wonder, I look for items ‘made in America’ and not imported and they are pretty hard to find. I don’t see how that’ll change without some major re-investment in American manufacturing though. It’s not like they can just start up the old closed down, shipped to China, factories and go. So this QE2 is meant to last for a long time to stimulate re-investment?
It probably won’t do much because we’re not at full capacity. We’ve got lots of idle resources. I think the idea is that any one that eventually ‘scales-up’ will do it here instead of there. That’s kind’ve a long run strategy though and a gamble. It’s not so much re-investment as re-opening stuff sitting around gathering dust here. And, that assumes that we manage to go lower than any one else. All of these are very big IFS. It could possibly be just plain so destabilizing that every one sits on there hands. That’s what Smoot-Hawley did during the Great Depression albeit it was more overt. We’re not doing explicit Tariffs and quotas but letting a currency devalue adds a ‘tax’.
oops, typo … on one hand … just caught that and corrected it. I was getting exhausted last night after spending the day loading software and drivers.
Yikes, I just published my first post a bit too fast. Do I delete it now, then republish, and how?
Nevermind, I figured out how to schedule it, and put it back a bit. Yeesh, I will learn to look first, then hit publish.
yeah, that’s always a problem. Some times folks don’t safe and if there’s not a draft out there, you never know and one will pop up out of no where … I just want to ensure that every one’s post gets some ‘alone’ time.
nope, it’s okay … this one won’t get much play any way … but you can schedule it … did you notice that option? That’s how I handle the morning posts. It’s near the publish button and if you use the pull down date you’ll see you can put it at any time or day. BTW, it’s on CST.
OK, I have to ask, is ‘Shots Fired’ an economic term of a warning towards inflation.
Seems deflation is the greater risk, at least of dollars worldwide.
I remember stag-flation from my youth. I don’t remember anything about how it was dealt with, but I know everyone is terrified of it. I can’t see interest rates getting that high very quickly though.
nope, no econ jargon, just a reflection of the war footing metaphors used for currency wars. It was a contributor to World War 2 so, it’s a dangerous posture.
weapons are tariffs, quotas, and currency devaluation
I have to admit, at first the title of the post was alarming, but now I see it was ‘The Dollar was the one shot’. 😯 So, this is like trade wars, but with currency? Do you have a video…like the morning one? BTW, the English professor was very good, even his drawings were easy to understand (I will have to keep an eye on his videos).
yup … we’ll have to see if MABlue can dig up another one!!! If not, I’ll do something later tomorrow. I just wanted every one to know that the meeting was happening and there’s going to be some fierce rhetoric. Believe me, this isn’t going away any time soon and it’s important because it’s one of the things that really contributed to WW2.
Here’s a short explanation from Dean Baker that looks good. Getting a good basic explanation is my goal tomorrow.
okay, try this one …
I liked the Krugman piece and I’m getting through the piece at Naked Capitalism. Learning much. I don’t think our policy makers will stand up to big business. I think the little guys will have to hurt a lot more before that happens. Very pessimistic view, I know.
I have to admit, since I’ve started reading your posts, I’ve learned not to worry so much about some things. It’s quite a relief. I worried tons about the budget and trade deficits. Now, not so much. I worry more about the effects of different policies on people and how to offset any negative effects.
Dak, I see the reaction of the markets to the Fed QE II. it seems to me that when commodity prices go up, we’ll get inflation. Okay. That’s fine and dandy because the Fed want’s to push inflation. But right now, millions don’t have jobs and the middle class has lost purchasing power these past 30 years with low wages. If we get inflation, gas prices and everything will go up, making it more difficult for people to consume. To me, it seems that the little growth we had will come to a halt and send us into a new recession. On top of that, we need to borrow money, and lenders are not going to buy U.S. Treasuries at 2 percent when inflation is being pushed. My main question is: Won’t the QEII be counter productive? That’s how I look at it with my basic Econ 101 and 102.
It depends on how quickly the credit channel is restored. there are three markets that must clear here: the real sector and prices, the money/bond markets and interest rates/yields and the foreign sector with exchange rates. If banks start lending vigorously, they’ll start mopping reserves up pretty quickly. I’ve heard Bernarke is actually asking for two things: more fiscal stimulus and an inflation target of 4 instead of 2 for the upper bound. That says he expects inflation. You can look at Japanese experience in the 90s though and they didn’t have any problems so that’s possible too.
Thank you. It’s great to come here and get some serious economic posts.
Dean Baker’s closing paragraph was interesting…
I’m guessing it’s a little bit of both, they don’t understand economic policy and they want to cut Medicare and Social Security. Like so many things in politics these days, it’s easier to be ignorant and pander to your masters.
Cutting social security and medicare becomes almost a religious thing (little r), doesn’t it? I don’t get these peoples’ point. I have many conservative acquaintances who rail against SS and Medicare. But man, talk about cutting THEIR benefit and they get all snippy and protective.
Maybe it’s like Pat Johnson said a while back in a comment on JWS, a comment that really made me think, some people are just greedy and mean. It’s too bad these types seem to rise to the top and get to make policy decisions.
Dak – this article represents why a make it a point to read your stuff every day. It gives me insight into a world that I know exists, but do not understand. Looking forward to the posts you plan to do.
Further comment – I just wish I could have more confidence in Geitner, Bernanke and Obama. Despite Bernanke’s thesis being on the depression, he missed regulating the very thing that created the finsncial crisis (unregulated mortgage entities). Geitner was in charge of regulating Citybank and flopped on that. Deapite his populist rhetoric, Obama seems to have been captured by the financial types (heckava job Larry).
So – my confidnece of them being able to do the right thing is limited. Obama is going on a 10 day world tour. We will have to see how well he is listened to. I contend that Obama was rolled by the congressional lobbyists in financial regulation. I expect that he will not be listened to by the other world leaders because he has a weak suit of cards.
Thanks! I’m going to be watching Japan and the Geithner tour today. This situation could really determine a lot of how things go the next few years in terms of jobs and the economy.
If the currency war is about having the weakest currency, surely Zimbabwe have won already? There must be a limit to how much a currency can devalue before inflation sets in and then an insipid, downward spiral is set in motion whereby currency devaluation and inflation feed off each other.
The APEC and G20 talks better establish some civility or we might as well re-established Smoot Hawley. At this point, I see no good coming from this unless some one starts some peace talks shortly. At least the EU and the Japanese are staying are being more cautious at this point.