Shots Fired

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.

So,  what’s up with Geithner?

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.

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.