Clash of The Currencies

The “shellacking” Obama and his democratic Congress received was not limited to the midterm elections. They also received a shellacking for their monetary policy at the G20 in Seoul last week..

While America demanded, make that ordered China to revalue the yuan with the threat of sanctions, America decided to print $600 billion to stimulate its economy with the second round of quantitative easing, commonly spun as QE2. The result, a weaker devalued dollar ─ 15-year lows against the yen and an all-time low against the Swiss franc ─ with China taking the biggest hit because of its multi-trillion dollar holdings. The result, instead of China being criticized for its currency policy at the G20 in Seoul last week, it was America that was roundly criticized by world leaders, including China, for its destabilizing currency policy that is causing trade imbalances and disparities not only at home but globally. The U.S criticism of China’s yuan policy and push to revalue the yuan was soundly rejected by world leaders who put the blame for the global clash of currencies squarely on U.S. shoulders.

The biggest force undermining the dollar is the U.S. Federal Reserve’s dollar printing policy, not China. It is time this is acknowledged and that the U.S. reconsider its exchange rate policy in rebalancing the U.S. economy. With the dollar’s interest rates in the U.S. at nearly zero, the country is printing more money and pumping it into the U.S. markets from where it flows to the rest of the world. As a result, the dollar has tumbled; inflation expectations have increased; asset and commodity prices have hit new highs. Even worse, the dollar’s appreciation has negatively impacted other economies and currencies, forcing them to act, either by imposing capital controls or intervening in their exchange rates.

Banks take the U.S. dollars the Fed prints and instead of investing and circulating them in the U.S. economy, look for better returns in emerging countries and create inflation, asset and housing bubbles with their hot dollars that they withdraw when they have maximized their returns, leaving the local economies in shambles as witnessed during the 1997-98 financial crisis. It should therefore not come as a surprise that countries as diverse as Brazil, Indonesia, South Korea, Vietnam and China have imposed restrictions on investment inflows to defuse the danger of hot money.

This is a “beggar-my-neighbor” policy. During the 2008-2009 crisis, the U.S. nationalized a lot of private debt, but in the post-crisis period, it tried to internationalize its public debt. The policy is shortsighted, beneficial to neither U.S. economic growth nor global recovery and stability. Shifting America’s accumulated debt burden across the world by softening the dollar only forces other countries to take action to protect their currencies. That ultimately isolates the dollar and its users. Historical experience shows that policymakers must be cautious about aggressively shifting exchange rates.

In the 1970s, the U.S. pursued a devaluation policy for the same purpose and using the same justifications. It led to chaos around the world and plunged the U.S. economy into a prolonged period of stagflation. Maybe the world can stop the U.S. from repeating the mistake, through currency interventions. This isn’t a currency war, it is good medicine, not only for the countries protecting themselves, but America as well.

The U.S. weak-dollar policy could backfire big time, leading straight to inflation without growth along the way. There is no mileage in politicizing currency management. There are no winners in a clash of currencies.