Currency fight could spark trade war

David Jessop, Trade Writer

For months, there have been global mutterings about an impending currency war between the world's major economies.

So serious has this possibility become, and the associated danger that it might spark a global trade war, the International Monetary Fund's managing director, Dominique Strauss Kahn, recently told the Financial Times: "There is clearly the idea beginning to circulate that currencies can be used as a policy weapon ... Translated into action, such an idea would represent a very serious risk to the global recovery .... Any such approach would have a negative and very damaging longer-run impact."

Put simply, what is happening is that emerging and developed economies alike have begun to seek ways, through the value of their currencies, to maintain or enhance their global competitiveness relative to each other in order to emerge from the recession.

Currency value

To achieve this, they are trying to ensure that the value of their currency remains low in order to increase exports and to maintain or develop their industrial base and levels of employment.

Although these measures are intended to defend the domestic economy, they reflect the continued process of rebalancing the global economy.

As a consequence, while the principal protagonists in the currency war have up to now largely been China and the US, increasingly, Brazil, India, Japan, the European Union and others are having to act to defend their interests.

In Brazil's case, there have been suspicions that, as a matter of policy, its government has been taking action to hold down the value of the real to protect its export competitiveness.

Brazil believes the developed world is seeking ways to devalue their currencies in relation to emerging nations, in an attempt to sustain and boost manufacturing and employment as they struggle to come out of recession.

Commenting on this in recent weeks Brazil's finance minister, Guido Mantega, has said Brazil will respond to such actions by taking steps to drive down the value of the real, which has been strengthening in recent months, largely as a result of his nation's continuing economic growth and the consequent influx of foreign investment and associated currency speculation.

In the case of China, there has been concern in the US and other developed nations for some time that Beijing has kept the value of the renimbi artificially low in order to maintain export-led growth, only recently accepting, with reluctance, that its currency should slowly appreciate in value by relaxing its unofficial peg to the dollar.

Although there are not as yet signs of a full-scale currency war, the US has gradually been increasing its public rhetoric by describing the Chinese currency as being 'significantly undervalued', and more recently still Japan has intervened in global currency markets to drive down the value of the yen after it hit a 15-year high against the dollar.

Economic advantage

The danger in all of this is that while governments continue to be cautious, there is growing awareness among legislators in both developed and emerging nations of the domestic implications of a global currency realignment.

They fear the economic advantage that artificially low currencies in emerging economies will enable nations such as Brazil and China to penetrate markets in ways that terminally affect older manufacturing industries.

As a consequence, there is a real danger of a move to protectionism if nations driven by such concerns legislate to erect trade barriers.

Already, the US Congress, conscious of the November mid-term elections, is considering legislation that would have the effect of threatening China with tariffs if it does not allow its currency to appreciate.

Responding, the Peoples Daily, the official voice of the Chinese Communist Party, has suggested that if the US Congress were to pass the bill, it would be a new example of the United States seeking to embrace protectionism through legislation.

Last week at the IMF's annual meeting in Washington, the issue of an impending currency war and the danger that it might lead to protectionism and a trade war was a primary focus.

All of this potentially presents problems for the Caribbean.

Without exception, its currencies are tied to or float against the US dollar.

Caribbean may suffer

Most of its export and tourism earnings are bound up with the US or Europe and the region has become, for the most part, economically dependent on visitor arrivals from the same developed nations that are only slowly coming out of recession.

This is unlike the region's neighbours in Latin America, who have used the past decade to diversify their international trading partners and investment relationships to include China and nations in Asia, through having a much wider range of offerings and, most notably, being able to develop new markets for their agriculture and minerals.

If, as seems likely, it will be China with its huge dollar holdings and investments in the US that, in the coming years, brings about a rebalancing of global currency and trade, the Caribbean, with its small economic base, large levels of indebtedness and deep economic ties with the US and Europe, may well suffer the same relative economic decline that the US and Europe now face.

If this is not to happen, action in real time is required to rapidly diversify the region's tourism product and airlift, to reduce food import bills through developing agriculture for domestic consumption and by finding new ways to reduce energy costs.

David Jessop is director of the Caribbean Council.

davidjessop@caribbeancouncil.org