Monday 23 Jul 2018 | 08:04 | SYDNEY
Monday 23 Jul 2018 | 08:04 | SYDNEY

Currency wars: Three steps to gridlock


Mark Thirlwell

13 October 2010 17:08

For anybody (was there anybody') hoping that last weekend's IMF meeting might provide some impetus towards a cooperative solution to the currency wars now threatening to distort the international economy, the result was a disappointment. Instead, the main takeaway from the meeting was – once again – the  difficulty in delivering meaningful international cooperation at the present time. According to the FT, one attendee described the meetings as 'futile and exhausting, with too many people reading prepared texts and not engaging in real arguments.'

Washington pressed for a greater focus on China's exchange rate policy, Beijing argued that US monetary policy was producing destabilising capital flows, and in the end the participants kicked the can down the road to next month's G-20 meeting in Korea.

Can the G-20 do better' As I have said before, I'm not optimistic. The practical process of policy coordination is often described as comprising three stages, each of which can involve serious obstacles to producing an effective agreement:

  • Stage 1: Countries decide what specific policy changes they want from each other and what they are prepared to offer in return. This involves reaching agreement on the target variables (eg. what size and sign of current account balance), the appropriate policy measures (eg. the balance between fiscal consolidation, exchange rate adjustment and so forth), and agreement on the impact of those changes (eg. the size and sign of the impact of a given exchange rate change on the current account balance – that is, agreement on the underlying economic model).
  • Stage 2: Countries must then negotiate over how the gains from coordination will be shared.
  • Stage 3: The final agreement must be enforced, requiring a monitoring process  and a policy on what should be done if one party fails to live up to its commitments.

All three stages are going to be problematic.

Start with Stage 1. Right now, we have no agreement on the nature of the problem. There is no consensus on what a sustainable current account surplus or deficit is, let alone what the 'optimum' value of those variables should be. There is no agreement on whether global imbalances were a major cause of the GFC. And there is no agreement on policy tools or the underlying model. For example, there are bitter disagreements over whether exchange rate adjustment will 'work', and over how far China's exchange rate is from its equilibrium value. 

Things look little better with Stage 2. Here, the increased size of the negotiating club (G20 vs. G7 or G5 in the case of the Plaza Accord) and the increase in membership heterogeneity (particularly in levels of development) make reaching agreement harder than in the past. I have described one aspect of this as the hypocrisy vs reciprocity problem.

Finally, Stage 3, and enforcement seems to present almost insurmountable difficulties. Perhaps the most plausible option for an enforcement mechanism is something based on peer review. This seems to be the way we are headed, with plans for the IMF to monitor international spillovers from country policies. 

But going on past performance, this seems unlikely to deliver: the IMF's earlier Multilateral Consultation on Global Imbalances was a failure. The same goes for the EU's process for monitoring fiscal sustainability, as recently evidenced by the Greek debacle. And effective peer review has really not yet been a starter in East Asia. Arguably the only significant success has been the OECD's process.

Yet if peer review is unlikely to deliver, what is the alternative' Some have suggested tougher measures, including levying taxes on the debt of non-complying deficit countries or imposing tariffs on imports from, and subsidies on exports to, surplus countries. But reaching international agreement on trigger levels for these penalties would be extremely hard. 

Alternatively, some version of the Keynes Plan for an international clearing union also seems out of reach. (See this Vox ebook for essays by Krueger and Dieter & Higgot on the former approach, and by Joshi & Skidelsky on Keynes' ideas.)

In the absence of a multilateral agreement, the remaining options are: living with some version of the deeply unsatisfactory status quo, or unilateral attempts by Washington to force Beijing to change policies. Options which have been canvassed include trade sanctions along the lines proposed by recent US legislation, off-setting currency intervention, or capital account measures

Again, all look problematic. It's hard to see how the debt proposal would be enforced; the efficacy of countervailing currency intervention is likely limited given China's tightly controlled capital account; and heading down the trade policy route risks a cure even worse than the disease.