Over the past month Ben Bernanke, the Chairman of the Federal Reserve, has pitted his fellow central bankers against each other in what is being labelled a ‘currency war’.
His decision to extend QE3 by printing money rather than issuing short-term treasures has further debased the US dollar against most currencies. In doing so Bernanke has revealed his tenacity in devaluing the currency to stimulate exports in pursuit of his mandate of full employment. Unfortunately, what seems to be in the national interest may not necessarily be so for the global economy.
In face of a falling US dollar many central banks in emerging and advanced economies have been unrestrained in vocalising their implacable disapproval for the Fed’s currency manipulation. The Chinese central bank has long before maintained a policy of intervention to prevent the Yuan from appreciating with the purpose of protecting the attractiveness of its exports in global markets. In doing so, China is harbouring worsening imbalances where growth is mainly driven by trade and productive capacity enhancing investment, whilst domestic consumption remains weak. This begs the question, is currency appreciation in emerging economies such a bad thing?
Although the Yuan has regained a modest increase against the USD over the past year to around 6.21CNY/1USD from 6.41CNY/1USD, the Yuan is still undervalued as a reflection of its consistent current account surplus compared to the US’s deficit. Conceding a significant appreciation of the Yuan will hurt China’s impressive export volumes, and may do more good than harm both domestically and abroad.
With a rising Yuan China’s access to cheap foreign capital would significantly improve, which can be conducive to a robust and healthy financial system as the cost of borrowing faced by Chinese banks falls. Importantly, the price of loans to households and businesses may become more attractive, encouraging an increase in lending and an improvement in consumption. This was the exact case when Greece entered the EU, whereby ditching the drachma for the Euro gave the country access to cheap capital from Germany. It may also help put fears of over investment to rest as cheaper financing will keep the marginal returns of investment viable.
With an internal rebalance may also come a global trade rebalance. Allowing for growth to come from other areas of the Chinese economy, the US and countries within the Euro would see a rise in export volumes accompanied with more sustainable current accounts. This too would improve employment levels as export industries begin to grow.
Unfortunately economics is filled with tradeoffs. Adjustments towards more sustainable trade volumes between the US, Europe and China still does not solve Australia’s woes, as a stubbornly high AUD persistently batters our trade exposed industries. With mining investment projected to be at its peak, Australia too must find alternative means of growth. However, it’s unlikely to come from industries whose competitiveness is constantly impaired by a rising AUD and arguably a looming productivity crisis. Glenn Stevens has mentioned intervention in the AUD as a remote possibility but fears a blow out in the RBA’s balance sheet. Stevens’ reluctance to devalue the AUD is merited, as it is difficult to escape the conclusion that the best intervention is no intervention at all.
As the Fed decides to meddle with its currency it would be imprudent not to consider the ramifications of an unintended obstreperous cycle of currency debasement between its trading partners. Most central banks risk creating nasty balance sheet vulnerabilities ultimately undermining the stability of global trade. In saying that, the Fed may not have felt the need to devalue the USD if most central banks in emerging economies were not already deliberately depreciating their currency to protect export growth. Maybe if foreign exchange markets were left free to decide prices there wouldn’t be any causalities of a ‘currency war’.