Currency wars – moving towards resolution?

As leaders of the G20 meet in Seoul this week, we may be finally coming to terms with the fact that the old model will never return. It was a model based on a voracious American appetite for imports and consumer goods, thus presenting an opportunity for developing countries to use an export-led growth model to lever themselves up.

The US appetite will shrink, partly because its savings rate is at last creeping up  — households are less likely to spend, spend, borrow and spend like they had been doing for the past 30 years – and because the US Dollar won’t be buying anything like what it used to.

Recognition that an era is passing can be seen in numerous actions taken by various governments, particularly the US and China. The US has finally lost patience and has unilaterally taken action that, while intended by the Fed to serve domestic policy goals, will clearly have the effect of devaluing the US Dollar. The Chinese, on their part have not only allowed the Yuan to rise again, but in recent pronouncements, have shifted their emphasis from simple growth targets to equity, quality life and environmental sustainability. Going forward, we’re going to see them make fantastic efforts at climbing the technology ladder, partly to compensate for the expected decline of their cheap manufacturing model.

At last, acrimony is giving way to a shared realisation that there is no returning to the old order.

Let’s take one issue at a time.

One of the big reasons why the US economy is in such a funk is that the American consumer is more careful with his money today. Household savings rate have been rising from a low of about 2 percent in 2007 to slightly above 5 percent based on September 2010 data.

With currencies, we are now in uncharted territory. The US Dollar is currently trading around Singapore Dollar 1.28. Against the Yuan, it has fallen from 6.83, a rate that the Chinese government had held for over a year up till last June, to today’s 6.66, a three- percent change.

The trend is expected to persist with 10-percent movement possible within another 12 months.

Between these two juggernauts — Americans spending less and the US Dollar buying less — the American consumer is not going to be the locomotive for the global economy in future.

The latest devaluation of the Greenback came from market worries hearing the news of the Federal Reserve deciding to “print money” to buy US Treasury securities from banks. Figures ranging from US$600 billion and up have been mentioned. The Fed itself has not put a cap on what it is prepared to do.

How much is that compared to the total USD money supply? There are different measures for money supply, but the most commonly used M2 and M3 figures are currently US$8.6 trillion and US$14 trillion respectively. Printing US$600 billion or US$0.6 trillion is not insignificant.

The Fed hopes to spur economic activity and reduce the jobless rate (currently 9.6 percent – unacceptably high politically) in the US. In normal times, the Fed would do this by reducing interest rates: with cheaper loans, businesses are more likely to borrow and expand, consumers more likely to borrow and expend.

Unfortunately with the current Federal Funds Rate and the Reserve’s Discount Window rate so close to zero, they cannot be lowered any more. Yet it is not spurring economic activity. Thus the decision to go for “quantitative easing”, a euphemism for printing money.

With low US interest rates compounded by the fear that the US Dollar will lose its value – any commodity with an oversupply loses value – there is capital flight to other currencies that offer better returns. Asian currencies, including the Singapore Dollar, are among them. With money flooding in, however, Asian countries see serious inflation risks. These have a tendency to create destabilising price bubbles for selected investments, e.g. stocks or property, the popping of which lead to wrenching dislocations.

The natural demand for more of a country’s domestic currency as foreign money pours in means that the domestic currency will rise. Governments however, are very wary of this, because it can turn their exports uncompetitive. The Chinese government, particularly, has until recently held the Yuan at a steady rate against the US Dollar, fearing that any rise will hurt its exports and economic growth, which it sees as essential to maintaining employment and social stability in the vast and populous country. But the flood of money (despite capital and exchange controls) is fuelling huge bubbles, and inflationary pressures have begun to push wages up.

In any case, as well-argued by Yukon Huang, a senior associate at the Carnegie Endowment and a former country director for the World Bank in China, in an article carried by Today newspaper, 8 November 2010, two-thirds of the inputs for stuff that China makes to re-export actually come from other East Asian countries.  As those other currencies rise, so the cost of inputs, and the cost of the final product, will rise too, despite the herculean efforts of Beijing to hold the Yuan steady against the US Dollar.

There is a realisation at last that one way or another, the costs and prices of Chinese exports will rise. There will come a day when low-end products will be uncompetitive form China.

There is probably also a realisation – it has been a long time coming — that it is stupid for China to keep on accumulating US Dollar surpluses when that currency is likely to decline.

As a number of recent reports suggest, China is changing course too. Straits Times journalist Ching Cheong, for example, pointed out in his column, 9 November 2010, that:

The mindset change is evident in the recently-released 12th Five-Year Plan, the country’s economic road map for 2011 – 2015.

What is no longer in the plan is the phrase jingji fazhan wei hexin – economic development as the core – a principle that has long guided Chinese policy. Professor Ye Duchu of the Chinese Communist Party’s Central Party School has noted that this is the first time in 20 years that the phrase has been omitted from an important policy document.

In line with the new thinking, the new five-year plan does not set a target figure for gross domestic product growth but pledges instead to grow the people’s income at the same rate as the GDP. It also shifts its focus from export-led growth to increased domestic consumption.

— Straits Times, 9 November 2010, Changing economic priorities in China

This suggests that Beijing seems to have realised that fast economic growth does not guarantee a country freedom from social instability – an excuse it has long used to justify its determination to keep the Yuan effectively pegged to the US Dollar for fear of hurting its exports. It is inequality that creates instability and inequality has to be addressed directly. Relying on trickle-down does not cut it. However, it is not clear if China has fully absorbed this lesson or what it is going to do about it.

Of course, China is not alone in its tardiness at recognising this. Many other countries, including Singapore, still pay mere lip-service to what should be a critical responsibility of government to even out economic inequality. So, even as some consensus may be at hand as to how to cool the “currency wars” between countries, we’ve hardly begun to address seriously the economic tensions within countries.

4 Responses to “Currency wars – moving towards resolution?”


  1. 1 Life as usual 9 November 2010 at 22:58

    Whatever it is, the US dollar will remain as the international currency. Can any other currency replace the US dollar? Not in the foreseeable future or for the next 10 or 20 years.

    That being the case, the man on the street in Singapore is indirectly seeing the effects of US quantitative easing, which is the ultra low bank deposit rates and the stock and property bubble. Of course some made lots of money through such bubbles, but not the majority who are ordinary Joes.

    Another thing is, despite the Sing dollar strengthening, inflation is pretty much the same or even worsen. Coupled with low bank deposit rates, this is really a bad time for ordinary Joes with ordinary salaries. But what to do?

    Singapore’s monetary policy is to adjust the exchange rate and not interest rate when dealing with external changes and uncertainties. And this does not seem to clearly help ordinary Joes. Unlike when deposit interest rates rise, ordinary Joes who are savers will benefit.

    The current situation, although bad in many ways, may drag on for a long time and life goes on as usual without much drama. Meaning nothing drastic will happen socially or politically in SIngapore as people get used to whatever conditions with time.

  2. 2 yuen 10 November 2010 at 05:27

    Top Print Edition Stories
    Published November 10, 2010

    China’s pre-emptive strike

    By JOHN FOLEY

    CHINA yesterday gave its trade partners a taste of what they want. But it was only an amuse bouche. The yuan strengthened by the largest one-day amount against the US dollar since market-based reform was announced in June.

    The timing looks more than auspicious. In just two days world leaders meet in Seoul to air their grievances about global imbalances, one of the biggest of which is – that’s right – the undervalued yuan.

    The surprise 0.5 per cent rise had a logic of sorts. China’s foreign reserves regulator unveiled new rules the same day to clamp down on ‘hot’ money inflows, while the central bank fretted about asset bubbles, and raised the yield on one-year government bills. That may have led investors to believe an interest rate hike was on the way. All things being equal, a higher interest rate should nudge a currency’s value upwards.

    Yet all things aren’t equal. China’s capital controls may be leaky, but not so much that a 0.25 per cent increase in rates would outweigh the cost of climbing the wall for most investors. Even two interest rate hikes wouldn’t really tip the balance.

    And it is hard to believe the market really drives the yuan, which in nominal terms has strengthened less than 3 per cent against the US dollar this year, as other Asian currencies have soared.

    Trade partners who see China’s currency as a subsidy to its exporters should be thankful for small mercies. A 0.5 per cent daily increase could, repeated over time, make a big difference to the value of the currency. But with the yuan still down 5 per cent in trade-weighted terms since June’s surprise reforms, far more is needed to get Beijing off the hook.

  3. 3 Orwell76 10 November 2010 at 07:08

    I think it’s time for leader of OPEC to price oil in a basket of currencies. USD, Euro, Yen and RMB.

  4. 4 Fox 10 November 2010 at 23:00

    “Thus the decision to go for “quantitative easing”, a euphemism for printing money.”

    Strictly speaking, QE isn’t printing money. You are thinking of seigniorage but QE isn’t seigniorage because the government doesn’t print the money and then turns it into revenue (as Zimbabwe used to do). It is used to buy securities which is mainly corporate-issued debt.

    “With low US interest rates compounded by the fear that the US Dollar will lose its value – any commodity with an oversupply loses value – there is capital flight to other currencies that offer better returns. Asian currencies, including the Singapore Dollar, are among them. With money flooding in, however, Asian countries see serious inflation risks. These have a tendency to create destabilising price bubbles for selected investments, e.g. stocks or property, the popping of which lead to wrenching dislocations.”

    Strictly speaking, the expansion of the US money supply (in USD) per se does not actually cause destabilising price bubbles in Asian countries. It is the expansion of the money supply in Asian countries that causes the price instabilities. For instance, for every 1 USD dollar that is created and used to buy 6.66 RMB, the People’s Bank of China has to print 6.66 RMB to sell the 6.66 RMB. Of course, the PBC doesn’t really have to print that 6.66 RMB but if it doesn’t, the RMB would appreciate against the USD and make Chinese exports more expensive.

    One may ask: what happens to the 6.66 RMB bought by foreign investor? He/she then uses the 6.66 RMB to buy Chinese corporate bonds or stocks and ultimately, 6.66 RMB is injected into the Chinese money supply which grows. It is that additional 6.66 RMB that pushes up domestic prices in China.


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