Today’s “currency wars” stand at the intersection of many critical issues. These include the ability of developing countries to deploy capital controls, the role of the US as global financial hegemon, the inadequacy of the global financial architecture, the power of the IMF, and the role of the BRICs (and other rapidly growing developing countries). All of these issues are at center stage both at today’s meeting of G20 Finance Ministers in Washington DC and at yesterday’s BRIC Summit in Sanya, China (which South Africa attended for the first time).
Let’s begin with a bit of context. In September 2010, Brazil’s Finance Minister, Guido Mantega, warned that policy makers in rapidly growing developing countries (such as his own) were being compelled to take steps against the triple threat of currency appreciation, inflation, and asset bubbles that were induced by high levels of international private capital inflows. These inflows were and still are being stimulated by the multi-track recovery and the low interest rates on offer in wealthy countries, such as the USA. Mantega invoked the term currency war here because he was attempting to draw a parallel between the currency interventions of the 1930s and those of today. In the former case, policymakers responded to the collapse of the world economy and political tensions by pursuing mercantilist “beggar thy neighbor” strategies that involved competitive currency devaluations and discriminatory trade policies. At present, central banks in many developing countries are responding to different challenges by deploying diverse types of controls on capital inflows and other measures, such as sterilization.
Will these national salvos solve the problem they aim to address? No, and indeed, in the absence of viable, representative mechanisms of global economic management, we may, in fact, descend again into a period of nationalist, beggar-thy-neighbor policies. But in the short run at least the sterilization and the new capital controls that are being layered over existing controls are helping to mitigate (though in some cases, only modestly) some of the appreciation pressures and asset bubbles induced by the flood of foreign investment into rapidly growing developing countries. Even so, currencies in some rapidly growing countries remain far too strong from the perspective of exports, and inflationary pressures are a very serious problem. In this context, some analysts have suggested that the inflation problem has solved the currency war. This is because the rising costs of imported food and energy mean that central banks will ultimately have to welcome currency appreciations. However, this optimism is nothing more than wishful thinking by those who fantasize that intractable economic problems are corrected by market adjustments. Brazil’s Finance Minister Mantega, not one given to such fantasies, recently responded to the daily question “is the currency war over?” with a resounding “no.”
How the currency war issue will ultimately be resolved is very much an open question at this point. Two types of responses are being pursued simultaneously.
Response #1: Nationally divergent responses
Within the developing world, not surprisingly, we do not find consensus on structural solutions to the currency war. As I’ve written here previously, some central bankers have taken great pains to make clear that they will not draw weapons in the war. Among such countries, Mexico’s policymakers are highlighting their opposition to capital controls, even though the peso has been appreciating significantly against the US dollar since 2010. Turkish, Chilean and Colombian policymakers have also publicly rejected capital controls as a means of dealing with the appreciation of their currencies. This is not to suggest that policymakers in these countries are sitting on the sidelines while their currencies appreciate and asset values balloon. With the exception of Mexico, these central banks have been buying dollars. And even in Colombia, policymakers implemented measures that they do not define as capital controls, but which are nevertheless of a piece with the prudential goals of controls elsewhere. For instance, Colombian policy wisely prevents domestic banks from borrowing in foreign currency to lend in pesos, restricts the use of short-term finance for long-term projects, and limits bets in foreign exchange derivatives.
By contrast, we can expect other countries to continue to respond to the currency war with unilateral measures, namely capital controls and sterilization. Countries like Brazil continue to put in place new measures to curb the appreciation of the real. For instance, recently the government put in place a 6 percent tax on repatriated funds that are raised abroad through loans or bonds with a maturity of up to 720 days (the previous limit was up to 360 days). South Korea also added to existing controls by introducing a levy of up to .2% on holdings of short-term foreign debt by domestic banks (with a lower tax levied against longer term debts).
This national divergence on responses to the currency war reflects many factors, not least of which are differing internal political economies, the continued sway of neo-liberal ideas in some countries, and perhaps also pride associated with dealing with the problem of an excessively strong currency in countries that have so long faced the opposite problem. There may also be skepticism about the efficacy of these measures, especially since Brazil’s real has appeared almost unstoppable in its appreciation.
One other interesting fissure among the BRIC countries has emerged. The Brazilian government has sided (to an extent) with the US against China on the matter of currency manipulation. However to be clear, Brazil’s Finance Minister has placed far more emphasis on the problems that are being caused by loose monetary policies in wealthy countries and the speculative flows of money unleashed by hedge funds and derivative markets.
Response #2: Incoherent multilateralism
In addition to these divergent national responses, we also find that the G20 and the IMF are struggling to articulate what can only be described as an incoherent response to the currency war.
Early in 2011 it appeared that France was going to use its new leadership of the G20 and G8 to press the IMF to take on the role of coordinating capital controls via some type of code or mandate on the subject. French President Sarkozy and his Finance Minister Lagarde have discussed the need for IMF coordination on capital controls, suggesting that this might be among the country’s signature issues. Some ECB officials and representatives of the German government seemed interested in this issue as well. But more recently the G20 has largely dropped the issue, no doubt because the French President himself is involved with events in North Africa and the Middle East, and European officials are caught up in continued fallout from the financial crisis (particularly the bailout of Portugal and the messy politics of Iceland’s referendum on repaying British and Dutch depositors). In this context, the drive to coordinate capital controls and address the currency war has taken a back seat to issues that are much more immediate.
The IMF seems to be picking around the edges of the currency war issue. A November 2010 report and two recent IMF reports suggest that the IMF might develop standards for the appropriateness of different types of capital controls, as Gallagher and Ocampo have discussed recently. If the IMF does take further steps to try to claim this power, then it will mean that we are back to 1997, and the very significant ground gained over the last two years on policy space for capital controls could be lost. It will be important for Fund watchers to stay on this issue and continue to make sure that such coordination—if it is to occur–does not presume a norm of liberalization.
It is encouraging that some developing countries, such as Brazil, have already weighed instrongly against any efforts by the Fund to take control over when and how countries can control capital. (They’ve also weighed in, quite rightly, on the Fund’s lack of enthusiasm for tackling the contribution of wealthy countries’ monetary policies to the carry trade activity that plays such a key role in the currency war.
A better direction?
The only real, enduring solution to the problems of currency pressures, trade dislocation, speculative bubbles and other global imbalances lies in the urgent but politically difficult challenge of constructing a new financial architectures that promote mutually beneficial coordination across countries on financial regulation, capital controls, and currency policies. Until this emerges, we cannot expect national policymakers to refrain from mercantilist currency interventions and we cannot expect multilateral bodies like the IMF and the G-20 to take serious, coherent, or even-handed action. But I am hopeful that developing country representatives have put the matter of recasting the global financial architecture back on the table, not least due to the global attention garnered by their unilateral actions on capital controls, their criticisms of US monetary policy and of the capture of financial regulation by the country’s financial community, and their push back against the IMF’s apparent interest in taking control of the conversation on capital controls.
It may also be the case that the evolution of the global financial architecture will change the terrain on which the currency war is being fought. Right now, the global financial architecture is being recast slowly (as I argue in a recent paper), not because of a specific plan or conference that aims to do so, but because the financial crisis itself has stimulated the expansion of existing and the creation of new bilateral, regional and sub-regional institutions and arrangements. The crisis has also been the mid-wife to the G20 and has fueled conversations among the BRICs, particularly its most powerful members, China and Brazil. That the BRIC Summit was held just before today’s G20 Finance Ministers meeting is notable. China’s government already let it be known that it is not interested in the US’ finger pointing at its exchange rate policies. Collectively, all of these developments and tensions are having the effect of rendering the IMF, the US, and the dollar less dominant in the global financial architecture. At the same time, the two-track recovery and the assertiveness of rapidly growing developing countries are helping to widen fissures in the old financial order. Looking back we may find that the salvos in today’s currency war are nothing more than the last gasps of a financial order that no longer is suitable to the challenges and realities of our time.