The last post by Win Thin demonstrates that Emerging market countries that are doing the best in this difficult economic environment are feeling serious currency pressure. Brazil is looking for a way to deal with the volatility associated with hot money flows its strong economy has attracted. We are in the midst of what I call twenty-first century competitive currency devaluations.
Guido Mantega, the Brazilian finance minister is calling it "an international trade war" in which every nation attempts to gain the upper hand via some sort of currency depreciation to pick up some extra demand at everyone else’s expense. This is beggar thy neighbour pure and simple. And it causing countries like Brazil to institute capital controls.
The FT reports:
Mr Mantega, who has made increasingly aggressive comments recently about the need to control Brazil’s currency, said governments around the world were trying to weaken their currencies to promote competitiveness.
“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness,” he said, according to Reuters.
The US dollar has fallen by about 25 per cent against the real since the beginning of last year, making the real the strongest performing currency in the world, according to Bloomberg.
In spite of Mr Mantega’s strong words, however, Brazil has so far held back from taking any action other than intervening in the local currency spot market.
How long will they continue to do so?
Barry Eichengreen, a leading Depression-era scholar, thinks these attempts at debasing currencies are a good thing. In a March 2009 article in the Guardian newspaper, he argued that a coordinated debasement would be preferable but that an uncoordinated debasement is better than none. This is something we learned in the 1930s, according to the account in his book Golden Fetters.
In the end competitive devaluation benefited no one, it is said, since all countries can’t devalue their exchange rates against each another. The only effects were to fan political tensions, heighten exchange rate uncertainty, and upend the global trading system. Financial protectionism if you will.
Now, we are warned, there are signs of the same. The Bank of England is not exactly discreetly encouraging the pound to fall. And just last week the Swiss National Bank intervened in the foreign exchange market to push down the franc. Will Japan, the United States and China be long to follow? Will we all yet again end up shooting ourselves in the foot?
In fact, this popular account is a misreading of both the 1930s and the current situation. In the 1930s, it is true, with one country after another depreciating its currency, no one ended up gaining competitiveness relative to anyone else. And no country succeeded in exporting its way out of the depression, since there was no one to sell additional exports to. But this was not what mattered. What mattered was that one country after another moved to loosen monetary policy because it no longer had to worry about defending the exchange rate. And this monetary stimulus, felt worldwide, was probably the single most important factor initiating and sustaining economic recovery.
It is true that the process was disorderly and disruptive. Better would have been for the countries concerned to co-ordinate their moves to a more stimulative monetary policy without sending exchange rates on a roller-coaster ride. But, not for the first time, they failed to agree. Those in the most precarious positions had no choice but to pursue the new policy unilaterally.
In any case, monetary easing achieved through a process of "competitive devaluation" was better than no monetary easing. Those countries that shifted in this direction first were also first to recover. But in the end – the end coming after an excruciating five years – they had all moved in the requisite direction, and they all began to recover.
My reading of the language the Brazilian finance minister is using suggests that, indeed, currency debasement does fan political tensions and leads to protectionism. Moreover, the situation in China has similar overtones and has led the Chinese to take action. Marc Chandler reported earlier today that the U.S. is also due to respond with a more aggressive approach this Wednesday as well.
Can a more protectionist (and destabilising) outcome be averted? Despite Eichengreen’s logic, I have my doubts.