Currency Wars: The Referee Fired, The Sport Begins

October 11, 2010 by Douglas A. McIntyre

The IMF was dismissed as the possible arbitrator in the growing currency dispute among the biggest countries. The US immediately said it would push China harder to boost what many see as the yuan’s artificially low value. China countered, arguing that any changes to the price of the yuan may take months or longer.

The dispute is not confined to the two large nations. There have been charges that Japan and Brazil have begun to manipulate their currencies, and that has caused most countries to protect their own trade balances by boosting the value of their own currencies.

There is nothing new in any of this. Almost no one expected China and the US to accept the IMF as a referee. There is too much chance that the agency would back one side or the other, and each side needs all of its weapons.

China’s foreign currency reserves have now risen to $2.5 trillion. Many economists argue that the People’s Republic does not want to damage the value of its US investments by dumping its US paper. But, China could move to cut its purchases slowly. That would cause America to face death by a thousand cuts and force it to raise interest rates to attract more investment from the capital markets. That is China’s real leverage, although the consensus is that the Mainland will refrain from using it.

The consensus, however, is often wrong. “Japan’s Ministry of Finance reported that China in August had sold more than JPY2 trillion of its short-term Japanese debt holdings, nearly reversing its accumulation of yen-denominated assets in the first seven months of this year, which had helped to push up the value of Japan’s currency and prompted government intervention. Markets reacted to China’s yen dump by pushing up yields on Japanese debt,” according to the Roubini analysis.

Experts have said that the House bill to force China to raise the value of the yuan may not be legal under international law. The Administration, however, will be pressured from Congress  ahead of the Midterm election to “do something” about China.  Remember that projections of how much risk politicians will take often undervalue the extent to which members of Congress want to keep their jobs.

There will be no currency or trade war between the US and China because it would be an imprudent decision on the part of either side. But, the advantages of good sense are often lost in the heat of the moment.

Douglas A. McIntyre

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