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Update on the currency wars
Saturday, 30 October 2010 08:06

As they left the IMF meetings a few weeks back, the US and China could not have been further apart.  The US was of course pushing China to revalue its exchange rate and boost domestic demand, while China was criticizing the US’s loose monetary policy and low savings.



Indeed, the US’s loose money seemed to be flooding into emerging markets and pushing up their exchange rates, something not possible in China with its fixed exchange rate and substantially closed capital account.  Fearful that this hot capital might one day flood out as quickly as it flooded in, emerging economies like Brazil, Indonesia and Thailand are trying to protect themselves by putting restrictions on inward capital movements.


How did it all play out at the G20 financial ministers’ meeting in Seoul last weekend? 


US Treasury Secretary Geithner fired a salvo at his G20 counterparts in the form of a letter containing the following shots:


. “G20 countries should commit to undertake policies consistent with reducing external imbalances below a specified share of GDP over the next few years” – apparently Geithner has figure of 4 per cent of GDP in mind.

. “G20 emerging market countries with significantly undervalued currencies and adequate precautionary reserves need to allow their exchange rates to adjust fully over time to levels consistent with economic fundamentals”.  In other words, China, please revalue!

. “G20 advanced countries will work to ensure against excessive volatility and disorderly movement in exchange rates. Together these actions should reduce the risk of excessive volatility in capital flows for emerging economies that have flexible exchange rates”.  In other words, if China revalues, we will stop flooding emerging markets with dollars. 

. “With progress on these fronts, we should reach final agreement to reform the governance structure [of the IMF] to increase the voice and representation of dynamic emerging economies.”  That is, if China plays ball, the US will allow it and other emerging economies to have more voting rights at the IMF.


In short, the US was sticking to its guns.


After all that noise, the G20 Finance Ministers’ Communique of 23 October 2010 seemed to have a consensus agreement.  Here you go:


“We are all committed to play our part in achieving strong, sustainable and balanced growth in a collaborative and coordinated way. Specifically, we will:

. in advanced countries, formulate and implement clear, credible, ambitious and growth-friendly medium-term fiscal consolidation plans …

. move towards more market determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies. Advanced economies, including those with reserve currencies, will be vigilant against excess volatility and disorderly movements in exchange rates. These actions will help mitigate the risk of excessive volatility in capital flows facing some emerging countries…

We have reached agreement on an ambitious set of proposals to reform the IMF’s quota and governance… Key elements include:

. shifts in quota shares to dynamic EMDCs and to underrepresented countries of over 6%, while protecting the voting share of the poorest, which we commit to work to complete by the Annual Meetings in 2012.”


These communiqués always “paper over” the cracks between different countries.  But could it be true that they reached agreement after all the “shock and awe” of the IMF meetings and Geithner’s letter?


According to the BBC report, Geithner believes China is now "committed" to allowing the yuan to go up in value.  He said that the Chinese "need the flexibility to run their policies in a way that makes sense for China".  He added: "And that requires that their exchange rate move up over time as they're now doing and we want to see that continue”.  "They've got a ways to go, but I think they're committed to do that."


Unbelievable, I know.  Is it really true?  How did Geithner and the Chinese solve their problems so quickly?  The Chinese may well be happy to increase domestic demand sufficiently, together with some exchange rate appreciation, to keep their current account surplus below 4 per cent of GDP.


This logic can be found in China’s 12th 5-year plan which was agreed upon on 18 October at the Fifth Plenum of the 17th Central Committee of the Communist Party of China. 


The plenum proposed as the major targets for economic and social development in the next five years to, inter alia: “to maintain stable and relatively fast economic growth; to achieve major development in economic restructuring; to universally raise people's incomes at a relatively fast pace; to remarkably enhance social construction; to continuously deepen reform and opening-up; to achieve substantial progress in transforming the economic development pattern; and to further consolidate the foundation for the making of a better-off society in an all-round way”. 


“Participants at the plenum stressed adherence to the policy of boosting domestic demand, maintaining stable and relatively fast economic development, and strengthening and improving macro-control measures. The plenum called for the establishment of a long-term mechanism to expand consumption, the optimization of investment structures, and quickened pace of the building of a new growth pattern that is jointly driven by consumption, investment and exports…” 


In short, it seems that the Communist Party of China believes that it is in China’s interest to implement the policies that Geithner and the G20 are pushing for, even though there is no mention of exchange rate adjustment.


With China always on the verge of social instability, raising household incomes and boosting domestic demand are perfect policies for making its restive citizens more happy and peaceful.


Have the Chinese and the Americans really found a ‘win-win’ solution?  We will see.  We still have next week’s meeting of the Federal Reserve Board which will likely decide on more quantitative easing.  Then there are the battlegrounds of the upcoming G20 and APEC Summits!


Stay posted for the next round!




US Treasury Secretary’s Letter to G20 Finance Ministers


Communiqué of the Meeting of Finance Ministers and Central Bank Governors

Gyeongju, Korea, October 23, 2010


Geithner says China is 'committed' to revaluing yuan


Fifth Plenary Session of 17th CPC Central Committee 





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