Although, at the moment, it is directed to the Chinese currency, once it is enacted, it can be applied to any country any time. China, on its part, has agreed to follow a gradual course despite pressures for immediate 20 percent to 25 percent appreciation of its currency arguing that it will lead to economic destabilization not only in China but also globally.
The most worrying phenomenon is that amidst cheap dollar policy of US vis a vis other currencies, many countries have already started to follow similar course fearing some sort of spiral effect. Japan, Thailand and South Korea have already intervened in the market to check appreciation of their currencies against the dollar. Brazil and European Union are also moving in that direction. If the appreciation of the currencies against dollar continues, that may lead to spread of competitive devaluation internationally. This will create risks of big instability in the global exchange rate system with the possibility of severe crisis sooner rather than later. It is worth noting that the last time the currency system collapsed was during the 1930s. That only led to a deepening of depression but also fuelled international rivalry that ultimately led to World War II.
After too much wrangling, US dollar was accepted as the international reserve currency under the Bretton Woods Agreement of 1944. Dollar was tied to gold at the rate of $35 per ounce. The aim, among others, was to establish a viable or stable world monetary system through a fixed exchange rate regime. By virtue of overwhelming economic dominance of the US, it somehow functioned well as the world money for quite some time. However, the regime rested on inner contradictions. For instance, the maintenance of international liquidity required an outflow of dollars from the US to the extent of fulfilling the required liquidity of the rest of the world. As obvious, there could be no such any built in linkages under bilateral trade.
Paradoxically, the dollar circulation in the world economy expanded way beyond the gold held by the US Treasury. The dollar-gold gap steadily widened throughout the 1960s. With the increased mismatch, then US President Richard Nixon declared on Aug 15, 1971 that henceforth the dollar could no longer be exchanged for gold. With this, the Bretton Woods system collapsed. But instead of making alternative arrangements, say through International Monetary Fund, a floating dollar regime was introduced in 1973. This led to instability in trade, finance and payment system worldwide encouraging hoarding, manipulation and currency swaps for quick profits by the speculators.
If the appreciation of the currencies against dollar continues, that may lead to spread of competitive devaluation internationally. This will create risks of big instability in the global exchange rate system with the possibility of severe crisis sooner rather than later.
Along with these increased practices, the strength of the US economy crumbled one after another after a series of crisis that began from early 1970s, which heightened at the time of the financial crisis of 2008. The currency war is the culmination of this. Now, there are growing symptoms of breaking down of present dollar-dominated international currency system under the weight of the mounting contradictions and systemic crisis in the global financial system. One good example of this is the bewildering rise in the price of gold, which is setting new records almost daily.
In this backdrop, US pressure on China to massively revalue its currency is mounting amidst continued huge trade surplus of China with US accompanied by mammoth foreign exchange reserve. The rising unemployment and receding of growth rate in the US is also building pressures within the US for compelling China to take prompt action. However, notwithstanding the undervaluation of Yuan as accepted by China too, the extent and mode of revaluation is highly debatable and far more complex amidst appreciation of Renminbi against US dollar by almost 20 percent from July 2005 to July 2008.
For instance, studies show that in 2005, there were about 58 percent foreign-funded firms involved in international trade that mainly used to import raw materials. This means, in the event of currency appreciation also, the cheap raw material prices could offset adverse effect on export competitiveness of China. Similarly, there are unconfirmed reports that dominant transnational companies in China engaged in trade might have used transfer pricing practices for avoiding taxes or capital controls. If it has been the case, much of the trade account may actually represent capital movements concealing the increased profitability of the US companies in the global market. More importantly, the pressure for nominal, not real, appreciation might have been influenced again by the speculative interest as in the case of Japan. Both theory and practices indicate that only real appreciation of currencies by raising wages and other internal demand-induced means could be more appropriate to enhance imports and thereby correct global imbalances.
Now the US has started blaming other countries as well by labeling aggressive currency manipulators. Therefore, it is engaged in dictating its exchange rate policy unilaterally simply ignoring that dollar being an international currency, it has the responsibility of coming up with some amicable long-term solutions. At the same time, one cannot ignore that being an international currency, dollar has enabled to extract world resources freely despite some internally-driven limitations. The fact is that other countries are simply trying to protect their currencies from being pushed up against the dollar.
Contrarily, the Fed is pumping liquidity and reserves into the domestic financial system to reduce interest rates, presumably to enable banks to earn their way out of negative equity resulting from bad loans made during the real estate bubble. The problem is that the US quantitative easing is benefiting the currency speculators and financial oligarchy. But in order to defend such a system, the US is threatening to plunge the world economy into financial anarchy if other countries do not agree to a replay of the 1985 Plaza Accord as a possible framework for engineering an orderly decline in the dollar.
But the world has seen that the Plaza Accord derailed Japanese economy by forcing its currency to appreciate while lowering interest rates by flooding its economy with enough credit to inflate a real estate bubble. It is interesting to note that the unilateral devaluation of its currency by Germany in 1985 against the Accord is often cited to be one of the instrumental factors for its big success on the export front.
The big question in global finance today is thus: How long will other nations continue to succumb as the cumulative costs rise into the financial stratosphere? The world is being forced to accept either financial anarchy or more blunt US interventions. The declining economic power of the US indicates that even with 1985 Plaza Accord type moves, US can no longer keep dollar as the stable international reserve currency. The recent statement of finance ministers of G20 committing to discourage currency war is simply rhetoric, not a solution. Indeed, there is an urgency of creating an alternative international reserve currency. Apparently, Singapore Dollar could be the best alternative.
Unless early initiatives are taken, the crisis in the global economic system will aggravate amidst deepening of crisis in the US, the epicenter of financial capitalism.
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