Michael Pettis, “Protectionism is Gaining Currency – Competitive devaluations threaten a trade war”

Protectionism is Gaining Currency – Competitive devaluations threaten a trade war, Financial Times

By Michael Pettis
Published: December 1 2009 20:22 | Last updated: December 1 2009 20:22
Vietnam’s decision to devalue its currency  by 5 per cent last week to protect itself from undervaluation of the Chinese renminbi, and the worried response from Thailand and other Asian countries, suggests the move towards global trade conflict may already be unstoppable. As one group of countries seeks to gain or maintain trade advantage by manipulating their currencies, the historical precedent suggests that countries that are not able to devalue will respond with trade protection, especially tariffs and other barriers, and global trade will suffer.
In the 1930s many, but not all, major economies imposed draconian constraints on trade which sharply contracted international commerce and almost certainly slowed the global recovery. It was widely understood then that the collapse in international trade would only worsen the crisis, and yet countries, seeking to protect their own positions, collectively engaged in behaviour that left them worse off.
American economists Barry Eichengreen and Douglas Irwin recently published a paper   examining the roots of the post-1930 surge in protection. They argue that during the 1920s and shortly after the onset of the 1929 crisis, several countries abandoned the gold standard and engaged in beggar-thy-neighbour competitive devaluations. These countries subsequently experienced rapid improvements in their trade balances and suffered much less from the ravages of the global contraction of the 1930s.
But others, most obviously the US and European “gold bloc” countries, were sharply constrained in their ability to adjust their currencies. These countries suffered much of the brunt of the adjustment as imports became more competitive against their domestic industries, especially in relation to countries that were less constrained. These were also the countries that were most likely to resort to what the authors call the “second-best” adjustment mechanisms – tariffs, import quotas, exchange controls, and so on.
“The exchange rate regime and economic policies associated with it were key determinants of trade policies of the early 1930s,” they wrote. “Countries that remained on the gold standard, keeping their currencies fixed against gold, were more likely to restrict foreign trade. With other countries devaluing and gaining competitiveness at their expense, they adopted such policies to strengthen the balance of payments and fend off gold losses.”
That should not surprise us. In a world of contracting global demand policymakers were concerned not just with measures to boost domestic demand but also with measures that allowed them to acquire a greater share of foreign net demand. The easiest way to do this was by devaluation. But countries that were unable to realign their currencies remained under pressure to find alternative ways of helping their domestic industries. They resorted to tariffs and import quotas.

The same thing may be happening again. Of course no currency is any longer tied to gold, so there is no country whose ability to devalue, as in the 1930s, is limited by a commitment to maintain gold parity. But there are countries whose abilities to manage their currencies are nonetheless severely constrained.
The US dollar, for example, is widely believed to be overvalued, especially in relation to the currencies of Asian nations. Because of massive intervention by Asian central banks, however, it is proving almost impossible for the dollar to adjust sufficiently, except against floating currencies such as the euro.
This creates a similar problem for Europe. Although few analysts believe the euro to be undervalued against the dollar – indeed, most believe it is more likely to be overvalued – it is nonetheless forced to bear the brunt of US dollar adjustment by further appreciation. This means that both the US and eurozone countries suffer from currency intervention and competitive devaluations elsewhere, with little room to adjust.
What can the US and Europe do? If Messrs Eichengreen and Irwin are right, they are likely to resort to the same “second-best” options available to them as countries locked into overvalued gold exchange rates in the 1930s. They will raise tariffs or otherwise intervene directly in trade, and it is pretty clear already that as US and European anger over currency misalignment grows, the recourse to protectionism is also growing.
Nearly everyone agrees that a world that retreats into direct and indirect forms of trade protection is a world that is worse off and likely to recover more slowly from the global crisis. But the fact that everyone seems to agree on this point should not allay our worries. In the 1930s, it was also well understood that the crisis would be exacerbated by plunging international trade. This did not stop a descent into protectionism which put the “Great” into the Great Depression.
Once again it seems we are going to make the same mistake. Countries that can expand their share of global demand by competitive devaluations are seeking to do so. Countries that cannot will almost certainly consider more direct forms of intervention. We should worry. Without serious global co-ordination, in which the US and Europe forswear protectionism in exchange for significant appreciation of undervalued currencies, rising tariffs appear inevitable.
The writer is a professor of finance at the Guanghua School of Peking University and a senior associate at the Carnegie Endowment

Kevin Brown and Tim Johnston, “Asia bank chief urges ‘serious’ talks on currencies”

Asia bank chief urges ‘serious’ talks on currencies, Financial Times

By Kevin Brown and Tim Johnston in Hua Hin, Thailand

Published: October 26 2009 02:00 | Last updated: October 26 2009 02:00

China, Japan and other east Asian countries must have “serious” talks on currency co-operation to prevent a recurrence of violent fluctuations that have raised trade tensions in the region, said the president of the Asian Development Bank yesterday.

Haruhiko Kuroda said currency movements threatened the growth of trade between Asian countries, widely regarded as a key way of reducing the region’s reliance on exports to the US and Europe.

“I think this is one area where east Asian countries are well advised to start a serious effort to co-operate,” Mr Kuroda said at the East Asia Summit between the 10-member Association of South East Asian Nations (Asean) and China, Japan, South Korea, India, Australia and New Zealand.

Yukio Hatoyama, the recently elected Japanese prime minister, is understood to have raised the issue informally with some leaders in the region, but there has been no comment from China, which has in effect pegged the renminbi to the declining US dollar.

Mr Kuroda said the east Asian countries, known as the Asean plus three grouping, had made substantial progress on regional financial stability through the $120bn Chiang Mai currency swap initiative, intended to combat short-term liquidity problems. But there had been no talks on a co-ordinated approach to currency movements. “I think the Asean plus three finance ministers could discuss this,” he said.

Traders say Thailand, Malaysia and Singapore are among east Asian countries that have intervened in currency markets recently to try to slow the appreciation of their currencies.

http://www.ft.com/cms/s/0/521d41e8-c1ce-11de-b86b-00144feab49a.html

Alex Frangos, “Yuan’s Fall Annoys the Neighbors”

HONG KONG — As the dollar continues to weaken, concerns are mounting in much of Asia over another descending currency: the Chinese yuan.

For more than a year, China has kept the yuan largely unchanged against the dollar. So, like the dollar, the yuan has been falling steadily against the currencies of China’s neighbors, including the Malaysian ringgit, the Indonesian rupiah and the South Korean won. That makes goods produced in those countries more expensive compared with China’s.

“If you have one large economy in Asia lock itself against the U.S. dollar, everyone feels pressure,” says Frederic Neumann, Asia economist for HSBC in Hong Kong. “Even 5% in this context feels painful.”

The countries that compete with China are at a critical juncture. To stem the rise of their currencies against the yuan (and the dollar), central banks around Asia have in recent months been purchasing gobs of greenbacks and building their foreign reserves. And now those reserves are back up to precrisis levels.

At the same time, Asian economies are under pressure eventually to allow their currencies to rise and reduce their emphasis on exports to fuel growth. Some economists and international policy makers fear continued intervention in currency markets would reflect an unwillingness to break old habits of export growth driven by policies that kept currencies undervalued. Intervention can also raise the risks of domestic inflation.

Federal Reserve Chairman Ben Bernanke echoed concerns about Asia’s role in rebalancing global trade in a speech last week. “We must avoid ever-increasing and unsustainable imbalances in trade and capital flows,” he said.

But for Asian countries shepherding fragile export recoveries, it is hard to take the world’s advice and allow their currencies to rise with the Chinese yuan falling along with the dollar.

“China has a fixed exchange rate that helps the Chinese companies a lot, and hurts us,” says Sung Jin Lee, president of the consumer-products arm of Bukang Sems Co., an Incheon, South Korea, manufacturer. Bukang makes everything from auto parts to antimicrobial mattress cleaners. Mr. Lee supports Korean intervention in currency markets, saying his profits will be squeezed if the won rises more than it already has.

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Dave Kansas & David Roman, “Dollar Weakens as Fundamental Flaws Get Laid Bare”

Dollar Weakens as Fundamental Flaws Get Laid Bare, Wall Street Journal

Dave Kansas & David Roman

The dollar swooned as investors expressed renewed concern about the greenback’s fragility in the presence of multiple challenges, including still anemic U.S. economic growth and yawning fiscal deficits.

More ominous days may be ahead for the dollar as investors start to sort stronger currencies from weaker currencies in a manner similar to how they sorted through good and bad banks earlier in the year. The looming stratification in the currency markets received a boost as the Reserve Bank of Australia became the first central bank from the Group of 20 to raise short-term interest rates since the financial crisis struck.

The Australian rate increase “is lifting all the boats” of currencies with higher-yielding debt, at the expense of the dollar, said Vassili Serebriakov, a foreign exchange strategist at Wells Fargo in New York.

Late in New York, the dollar tumbled to 88.80 against the Japanese yen — its lowest end-of-day price since Jan. 22 — from 89.53 yen on Monday. The euro rose to $1.4718 from $1.4653. The Australian dollar soared to 0.8897 against the U.S. dollar, its strongest point against the greenback since August last year.

Asian Intervention?

Traders believe that several Asian central banks intervened in the foreign-exchange market to curb the rise of their currencies against the dollar, primarily to keep their exports competitive. A rising currency would make exports relatively more expensive.

The interventions by South Korea, Singapore, Thailand and the Philippines — reported by currency traders, but not confirmed by the authorities — came as some Asian currencies hit 12-month highs against the dollar and exacerbated worries about the dollar’s outlook.

Korean traders said the central bank there appeared to step in since early trade to buy the dollar, possibly with the intention of pushing it above 1,170 won. The dollar was at 1,166.32 Korean won in New York. Kim Ik-joo, director-general of the International Finance Bureau in South Korea’s Ministry of Strategy and Finance, blamed “foreign players” for the rise of the won, which has climbed 8.2% against the dollar over the past three months.

There seems to have been a number of interventions in recent weeks as the dollar’s weakness has become a larger concern. Last week, the Swiss central bank intervened to tamp down the Swiss franc, according to traders. The Swiss National Bank declined to comment. Japanese authorities have also talked about intervening to reduce the upward move in the yen, but have done nothing so far.

The dollar’s weakness could prompt another round of questions about its role as a reserve currency, something that leaders in Russia, Brazil and China have raised during the past year. Few expect the dollar to lose its reserve position anytime soon, but mere discussion of the possibility creates a tougher trading environment for the buck.

Nest Rate Booster?

Foreign-exchange traders anticipate that the Norwegian central bank will soon join the Reserve Bank of Australia and also raise short-term rates. The oil-rich Scandinavian country, along with resource-rich Australia, Canada and New Zealand, seem best positioned to recover quickest as global growth starts to resume. One reason: China, with its voracious appetite for resources, is expected to lead at least the early parts of the recovery. That notion is one reason that these so-called commodity currencies are rising.

Unlike Australia, the U.S. has interest rates near zero and the Federal Reserve has taken several radical and creative steps to ease monetary conditions in a bid to boost economic activity. Most expect the U.S. will maintain its super-easy monetary policy for some time, even as other nations start to tighten policy. That means investors will be paid more, in the form of short-term interest rates, to hold currencies other than the dollar, which will place more pressure on the U.S. currency.

“Markets are looking for excuses to sell the dollar and kind of constantly finding them,” Wells Fargo’s Mr. Serebriakov said.

Pounding on Sterling

Along with the dollar, the British pound also stumbled. The pound fell against the euro and yen after an economic report showed industrial production surprisingly declined in August, undercutting hopes of nascent recovery in the U.K. economy. In the wake of the Australian rate increase, the pound dropped to its lowest level against the Australian dollar since 1985.

Analysts believe that the U.K. economy, leveraged more to the finance industry than other major economies, faces the prospect of a long and slow recovery.

—Bradley Davis, Alex Frangos and Neil Shah contributed to this article.

http://online.wsj.com/article/SB125483496626567541.html