The currency war starts not with a bang, but with buckpassing

The past week has seen an escalating series of news stories about a looming "currency war," as country after country tries to drive their currency downward, the United States blames China as the source of original sin on this, and China pisses off yet another country responds by digging in its heels, and the IMF wrings its hands.

If you need to read one article on why things are going down the way they are, it's Alan Beattie's excellent survey in the Financial Times of how countries as responding to this situation: 

Washington is looking for allies -- particularly among the emerging economies, who complain about their own competitiveness and volatility problems -- in its campaign for exchange rate flexibility. Trying to take on Beijing single-handed makes the US vulnerable to the charge that it is a lone complainant blaming its own profligate shortcomings on the country that is kind enough to lend it money, holding the best part of $1,000bn in U.S. Treasury bonds…

Yet despite U.S. claims of broad support, backing appears sporadic…

[S]ome U.S. policymakers privately complain that European backing is patchy and tends to go up and down with the euro. In the first half of the year the euro was pushed lower by the gathering Greek crisis, by early summer falling 17 per cent below its January level. Focused on local difficulties, and with the German export machine powering ahead, European officials saw little need to take on Beijing over currencies and had little energy to do so… 

Across the emerging economies, the plan of attack seems to be to keep quiet and pass the ammunition. Despite widespread recognition of the distortions China’s exchange rate policy appear to be causing, governments have generally preferred unilateral in­tervention to a public slanging match.

True, in April the governors of the Reserve Bank of India and the Central Bank of Brazil complained that Beijing was hurting their exporters.

But recently Celso Amorim, Brazil’s foreign minister, told Reuters: "I be­lieve that this idea of putting pressure on a country is not the right way for finding solutions." Significantly, he added: "We have good co-ordination with China and we’ve been talking to them. We can’t forget that China is currently our main customer…"

With the prospect of diplomatic progress limited, currency policy in the U.S. and Europe may end up being conducted through domestic monetary policy. If, as seems possible, the U.S. Federal Reserve, the Bank of Japan and the European Central Bank return to quantitative easing in order to boost growth, their currencies are likely to weaken -- as the yen briefly did after the Bank of Japan’s announcement of looser monetary policy this week.

So, to sum up: 

1) Every country is free-riding/buckpassing on this issue, hoping that the United States can dislodge China on its own.

2) The international regimes designed to prevent free-riding like this -- namely the G-20 and the IMF -- are not up to this task. [What about the WTO? -- ed. Fuggedaboutit.]

3) The source of China's rising power is not its hard currency reserves or its command over scarce rare earths, but its burgeoning domestic market.

4) Ironically, the United States and other countries want China to accelerate the growth of its domestic market, which would in turn give it more power. Even more ironically, China doesn't want to do this right now.

5) The sum effect of all of this will be a series of uncoordinated interventions into currency markets that will increase market volatility, political posturing, and eventually lead to the erection of capital and/or trade controls. 

Developing… in a very disturbing manner. 


Daniel W. Drezner

The declinism industry in America

My post yesterday on following Vizzini's advice U.S. retrenchment from Central Asia generated a bit of pushback. I should point out that my concern here is that the U.S. husbands its power resources with a bit more acumen. Sure, Central Asia has some strategic significance, but the thing is, every region in the globe has some strategic significance. If I'm rank-ordering U.S. strategic priorities, it would go as follows: 1) East Asia; 2) Latin America; 3) Europe; 4) Middle East; 5) South Asia; 6) Central Asia; 7) Africa (there's also a big gap between 4 and 5 on this list). Scarce resources devoted to Central Asia have to be siphoned from somewhere, and I don't want too much of a diversion from other strategic priorities.

That said, I want to clarify that I'm not saying that the U.S. is in terminal decline and therefore should engage in a systematic strategic retreat. David Bell makes an excellent point in The New Republic today -- there has been a perpetual declinism industry in the United States since the launch of Sputnik.

Twenty-two years ago, in a refreshingly clear-sighted article for Foreign Affairs, Harvard's Samuel P. Huntington noted that the theme of "America's decline" had in fact been a constant in American culture and politics since at least the late 1950s. It had come, he wrote, in several distinct waves: in reaction to the Soviet Union's launch of Sputnik; to the Vietnam War; to the oil shock of 1973; to Soviet aggression in the late 1970s; and to the general unease that accompanied the end of the Cold War. Since Huntington wrote, we can add at least two more waves: in reaction to 9/11, and to the current "Great Recession."....

What the long history of American "declinism" -- as opposed to America's actual possible decline -- suggests is that these anxieties have an existence of their own that is quite distinct from the actual geopolitical position of our country; that they arise as much from something deeply rooted in the collective psyche of our chattering classes as from sober political and economic analyses.

For whatever reason, it is clear that for more than half a century, many of America's leading commentators have had a powerful impulse consistently to see the United States as a weak, "bred out" basket case that will fall to stronger rivals as inevitably as Rome fell to the barbarians, or France to Henry V at Agincourt.

On the foreign policy front, selective U.S. retrenchment doesn't imply terminal decline so much as a temporary realignment to ensure that American power and interest are matched up going forward.

Question to readers: does retrenchment presage resurgence?