This piece originally appeared in the Financial Times.
How ironic that the world’s reserve currency issuer (the US) and its long-term rival to that status (China) are competing to nearly debauch their own currencies? America’s behaviour – more effect than intent – takes the form of quantitative easing. China’s takes the form of not letting its currency strengthen (which makes the recent monetary tightening deflationary for others).
But unilateral American action against China cannot be the basis for resolving the currency wars. Effective and legitimate multilateral action to induce Chinese co-operation is necessary. Mobilising a broader coalition of the “affected but as yet unwilling” countries before the upcoming Group of 20 summit in Seoul should be America’s priority.
US unilateralism runs into two difficulties, internal and external. Domestically, America is divided. At a time of high unemployment, labour groups seek strong action against the undervalued renminbi. But US companies are ambivalent because capital is mobile and can escape the effects of the undervaluation.
The external problem is China’s possible retaliation. Chinese threats of dumping US Treasury bonds are perhaps overstated. Why would they take action that would result in the very outcome – dollar decline – that China has worked to avoid? But other retaliatory options could hurt. China could leverage its economic status as a large buyer of goods and services (commercial and defence) to hurt American businesses and jobs. It could withhold co-operation on North Korea and Iran.
That America is divided is clear from Treasury secretary Tim Geithner’s decision to postpone pronouncing on currency manipulation, and from the weak legislation passed by the House of Representatives, which would affect a small fraction of Chinese imports. Martin Wolf’s point, in his FT column, that America has unlimited ammunition in the currency war, namely it can flood the world with dollars, is true – but this is more of a problem for countries open to capital than for China. In short, America can bark at China but not really bite.
The legitimacy of US unilateralism is also open to question. To a growing chorus of observers, retaliation is defensible because China is not playing by the rules: $2,500bn of reserves acquired though foreign exchange intervention provide evidence of China’s beggar-thy-neighbour policy. But China could counter that its policy is one of beggaring a much richer neighbour. If an undervalued renminbi destroys 500,000 US jobs (as my colleague Bill Cline estimates) could it not also create several times as many jobs in China itself, many of which would raise people out of poverty?
Multilateralism can help overcome the legitimacy problem. Several developing countries are affected by China’s policy. They are less able to cope with capital flows and overheating because they cannot easily let their currencies appreciate if the renminbi is fixed. Increasingly, they are resorting to capital controls. And their tradable goods industries are affected by the structural undervaluation of the renminbi. Even a committed cosmopolitan can, with a clear conscience, point a finger at China if it is beggaring a poor neighbour.
Multilateralism could work because China would incur the opprobrium of working against not just rich but poor countries, and hence against the entire financial and trading system.
But so far the affected countries have not been willing to speak up, mindful of their bilateral relationships with China. And, until recently, US diplomatic efforts have been insufficient because of over-confidence in its unilateralism. US quantitative easing and the policy problems it creates for emerging markets might be the spark that helps forge a broader coalition.
With Japan and the European Union now more vocal about the renminbi, the US could achieve a critical diplomatic mass if it can persuade, say, Brazil, Mexico, India, South Africa and Korea to form this coalition. Once political agreement is secured at the G20, implementation can be left to the IMF or the WTO or a combination of both as Aaditya Mattoo of the World Bank and I have proposed.
Multilateralism – with a more prominent role for emerging market countries – is essential now to prevent competitive currency debauchery by China and the US from blowing up the system.