The growing Gulf within the G-20
As expected, the G-20 summit in Seoul this week was dominated by the issue of competitive devaluations of currencies by economies around the world. At the epicenter of the debate was the Federal Reserve’s recent quantitative easing program, dubbed as QE2. The Federal Reserve announced last week that it plans to purchase nearly $600 billion of government bonds to stimulate the economy and stoke inflation in the US economy to more acceptable levels. Countries such as Germany, Japan, Brazil, South Korea and China which are largely export drive economies have targeted the action taken by the Fed as a deliberate move to devalue the US Dollar. Emerging countries fear that the Fed’s bond repurchasing program which is expected to drive interest rates down will result in a large influx of foreign capital in their respective countries. Central banks in India, Australia and China have already recognized this potential issue and have responded by hiking interest rates. In reaction to QE2, Germany’s Finance Minister, Wolfgang Schäuble said, “It doesn’t add up when the Americans accuse the Chinese of currency manipulation and then, with the help of their central bank’s printing presses, artificially lower the value of the dollar.”
The diatribe against QE2 proves to be another chapter in the global currency dispute. The US has been engaged in a long tussle with China over the value of the Yuan. The US believes that the Yuan is being artificially undervalued and has long urged China to allow the Yuan to float freely and move in line with market forces. The Yuan’s appreciation has been rather modest thus far and the US has targeted China for not doing enough in this regard. At the G-20 Finance Ministers summit held in Gyeongju, South Korea in late October this year, Treasury Secretary Tim Geithner proposed limits on current account surpluses of countries. Secretary Geithner suggested that countries limit current account surplus to a fixed percentage of GDP so that countries running a trade deficit are not at a disadvantage. The suggestion drew the ire from export driven economies such as Germany, Japan, Brazil and China. Germany which has seen a significant rise in exports this year criticized the proposal. Germany fears that it may be placed in the same category as China even though the Euro is freely traded. Moreover, Chancellor Merkel is of the view that a exports are a key indicator of a country’s competitiveness and limiting the current account surplus would blunt the competitiveness of the German economy. Though a specific limit has not been proposed, the US proposes to set the limit at 4% of GDP. Given that Germany’s current account surplus stands at 6% of GDP and much of its robust growth this year can be attributed to a surge in exports, the Germany’s apprehensions seem to be well founded.
China has also latched on to QE2 as a means to turn the tables on the US. It is believed that stimulating the US economy through quantitative easing is merely a pretext to devalue the US dollar and make US exports more competitive. At the G-20 summit, President Obama faced a tough time defending the Fed’s move and stated that the action taken by the Fed was not only essential for the US economy but also the rest of the world. This serves as a clear indication of the decreasing clout held by the US in international summits.
Though progress was made on various counts such as increasing the voting power of emerging countries in the IMF and laying the foundation for creating a financial ”safety net” to ensure the smooth winding down of large international banks in case of their failure and avoid taxpayer bailouts. However, the divisions within the G-20 which were visible for all to see have made it rather difficult for countries to arrive at a consensus. In a period when economic recovery in developed countries has been far from robust, unilateral actions and taking decisions without accounting for global implications would undo all the hard work put in prior to the crisis. Much of what the G-20 proposed to achieve at the meeting has been left unfulfilled. For instance, the countries decided to postpone a plan to develop indicators against which trade imbalances can be assessed and measures to redress the imbalances can be adopted. The countries were faced with the difficulty of developing a clear cut method to identify the “indicative guidelines” by which trade surpluses and deficits could be gauged.
Given the significant differences in opinion within the G-20, it is safe to say that it will take a while before countries start cooperating and looking beyond their immediate self interest. Though most countries recognize the dangers of engaging in currency devaluations to either boost short term exports or retaliate against similar steps taken by other nations and protectionism, they have not been able to agree on a method to address the inherent disadvantage countries have while trading with trade partners with a huge surplus. Placing limits on current account surplus will not gain unanimous acceptance within the G-20 because it effectively asks countries such as Germany, Japan and China to cut back on one of the lifelines of their respective economies. The US argues that large exporters must try to substitute exports with domestic demand. Though this can be achieved in China, offsetting exports with domestic demand will be difficult to achieve in mature economies such as Germany and Japan. Thus, it is hard to see the major economies, which are separated into two camps at the moment, reconciling their differences in the foreseeable future.