Similarly, in their issue of November 12, 2011 the ‘Financial Times Magazine’ states ” the US senate has passed a bill to penalize countries that manipulate their exchange rates – a move aimed squarely at China. Central banks in the US, UK and Japan have printed record amounts of money, either explicitly to weaken their currencies or with a weaker currency as a welcome side effect. Even the Swiss franc, normally the closest the world has to a hard currency, has been pegged to the euro, putting Switzerland’s money creation into overdrive. Yet, for now at least, no one is heading for the hills. Countries may be struggling to gain trade competitiveness in order to ease the post-crisis economic pain but few observers fear large-scale trade wars will result, let alone real bullets-and-tanks wars”.
Fifthly, we find that both the US and China, each has a role to play in the ‘currency wars’. From the US side: In the G20 of November 2008, the US advanced its vision for a kind of global bargain, under the name “rebalancing”. GDP grew to approximately $14.9 in early 2011 and the components were consumption 71%, investment 12%, government spending 20% and net exports -3%. Still this was above what the economy had before the recession in 2007, even though the economy wasn’t growing enough to carb unemployment from the high level reached in early 2009. The remedy for this problem was to come from the consumer.
Government spending and investment was also to play a role but the consumer had to so at 70% or more of GDP. To get the economy moving, a combination of low interest rates, easier mortgage terms, wealth effects from rising stock market and credit card debt had to be used to get the economy back to normal again. What came out was that the consumer was highly leveraged and many Americans owed more on the mortgages than ever before.
The consumer was really in trouble with high unemployment, retirement looming and children’s college bills coming due in a state of desperation wasn’t easy for many. Investment later on could also not work properly without the consumer playing his role. To reverse the situation, the US increased government spending but after four stimulant plans from 2008 to 2010 without creating new jobs, a revolution to make new government spending was made. Later on the Obama administration decided to keep consumption, investment and government spending out of play by increasing net exports.
The idea was to double net exports but how could it be done without harming their trade partners? This is basically how the currency wars started by the US implementing the quickest way of increasing exports which is to devaluate the currency. China’s Yuan was a US target number one and to affect it quickly, consumption dropped to 38% instead of 70% of the Chinese economy. Net exports, which used to be -3%, became 3.6% to the Chinese total. China’s growth was due to investment 48% of GDP, vs only 12% of the US. Here, a simple rebalancing was in order because if China could buy goods from the US such as video games, Hollywood films, PC software etc.; both countries could grow.
China had to increase consumption and reduce exports while the US does the contrary. The new exports in the US could have created jobs but all this could not be done through exchange rates alone, so, according to Geithner, the Secretary of US Treasury, a good part of the policy approach was a revaluation of the Yuan. However, the social structure in China obliged that individuals save much in order to cater for their retirement needs, which reduced consumption by China in favor of the US. Therefore, China needed to change its social culture to increase consumption from the US while the latter harvests the fruits of a rapidly growing Chinese market.
In the end, here we understand, like the US and China do, all the above was to be done in favor of the US alone (“rebalancing” in complete definition). The idea of approaching the G20 for help in making China and the US implement the above strategies didn’t work even after the meeting of their (US & China or G2) presidents in January 2011. After that it was vey clear that if the US wanted to cheapen its dollar against the Yuan, it had to do it on its own and with its own policies and strategies.
Months passed and in June 2011, the US was becoming the winner it this ‘currency war’. The weapon used is what’s normally called ‘Quantitative Easing’ or QE which was to create a general inflation abroad in both the exporting and developing nations altogether. So, printing more US bills did this. The Fed bought T-Bills from banks with a global customer base such as big banks, central banks and institutions. By doing this, the Fed increases money supply in all the countries, including China. But the more money the US printed, the more money China printed to peg the Yuan to the Dollar.
Later the Fed decided to stop wasting its dollar because of lack of hope to overtake China in this way. After this the US inflation was exported to the Middle East, Asia, Latin America and Africa in all those countries that failed to peg their currencies against the dollar. A worst situation resulting from an increase in the $ supply was the Arab Spring because the permanent increase in world food and energy prices led to hunger and ultimately to riots and the like. But the harm of this exported inflation to China wasn’t alarming6.
On the side of China however, we see that the US has failed until now but what’s next? In their book entitled ‘Currency Wars’, Uri Dudush and Vera Eidelman say, “…China, would be well advised to adopt more flexible currencies. This is not only in their interest-allowing monetary policy to target domestic demand as their financial markets become more integrated with those in the rest of the world-but would also help preempt trade tensions and ensure the smooth functioning of the international monetary system”7
In conclusion therefore, let’s go back to the words of our famous economist Joseph Stiglitz8 where he says that the US has accused China to be a ‘currency manipulator’ buy keeping its Yuan pegged to the US Dollar but goes ahead to say that China is actually not the one with the highest current account surplus in the world. He says its figure (5% of GDP) is lesser than Germany’s 5.2%. Let’s see it on the figure below9 but figures are more recent by the ones of Joseph Stiglitz:
Joseph Stiglitz continues saying that “No one wins from a trade war. So America should be wary of igniting one in the midst of an uncertain global recovery – as popular as it might be with politicians whose constituents are justly concerned about high unemployment, and as easy as it is to look for blame elsewhere. Unfortunately, this global crisis was made in America, and America must look inward, not only to revive its economy, but also to prevent a recurrence”. Finally, how will the issue be brought to an end?
While reading from the ‘strong dollar’ policy of the US: Alice-in-Wonderland semantics vs. economic reality, we find that no matter what had happened, the strong dollar policy has been a success despite persistent depreciation of the dollar, budget deficit and high and rising government debt. The reading continues by saying this situation can be reversed by the government keeping a close eye on treasury yields, rebalancing the US economy by continuing loose monetary policy. While any eventual fiscal tightening might put downward pressures on the dollar, an alternative fiscal crisis in the US can also weaken the dollar even though anyone of these would not mark the end of the dollar as an international currency as per now but because of all that, a strong alternative currency is needed though none is currently viable10.
From the above, there was and still is a generally accepted truth that the US dollar is used as a world currency (since the Bretton Woods agreement after the second world war). Until 2006, 66% of the world’s central bank reserves and more than 43% of all cross border transactions were in dollars and most oil contracts were written in dollars. Apart from the dollar, there’s the Euro with only 25% of central bank reserves and 39% of cross border transactions in the same year. However, the problems still emerge from these country currencies because the dollar has problems (such as with the Yuan) and even the euro has recently reduced in trust due to different financial crisis in its country members.
Therefore, China and Russia in March 2009, suggested that the world develops a single currency that would be disconnected from the individual nations and could maintain its stability in the long run while removing deficiencies caused by credit-based national currencies. China is worried because of its $ 2 trillion holdings in US $ which might become useless due to continued increase in US deficit spending and printing of US treasuries to support US debt. So, who would be responsible for creating such a currency? China says it’s the IMF that has the ability to develop a currency to replace the US dollar as a world currency. Represented by Tim Geithner, the US said it would support the idea even though later on US president Barack Obama said he supports a strong dollar (therefore not buying the idea)11.