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Currency war: Overflowing dollar against other currencies

By Shi Jiaqi (chinadaily.com.cn)
Updated: 2010-10-26 11:25

Their concerns are shared by the head of the International Monetary Fund Dominique Strauss-Kahn. At a conference in Shanghai on Oct 18, he cautioned that the huge capital flows into Asia could lead to exchange-rate overshooting, credit booms, asset-price bubbles and financial instability. He even suggested that controls on the volatile short-term capital will help moderate the risks.

The third front of the war: the fight between the dollar and the renminbi. While the world is already getting tired of this five-year-old dispute, Washington is determined to keep the issue alive.

The new methods that the US adopted most recently includes multi-lateralizing this bilateral issue by encouraging other economies to pressure China to sign on to a global deal, promoting the IMF as a key forum for negotiating currency issues, introducing a new rule to normalize, or "marketize" the exchange rates policy, and setting numerical targets for the main surplus countries.

It seems that America is partly successful in pitting some emerging economies against China. They criticize China for gaining an unfair advantage in the global competition by depreciating its currency together with the US dollar. However, this strategy is doomed to backfire. First, they will very soon come to realize that China is just doing what they want to do--to protect itself in an uncertain world. Second, they have already figured out the real sources of the problem. If America, the biggest reserve currency issuer, does not stop pumping liquidity into the world economy, the world will be inevitably be dragged into an enormous disaster.

The US strategy will not work on China. If history is any guide, it's obvious that America's domestic economic problem can't be resolved by external measures. Although the US government blames the high unemployment at home on China's exchange rate regime, the sharp depreciation of the dollar in both the early 1970s and mid-1980s did little to help the US economy to fundamentally adjust its external imbalances. What did help is the emergence of new industries and a new global competitiveness America found in those industries.

No serious scholars will buy the theory that a sharp appreciation of the RMB will help address America's problem. The only certain consequence it may have if China accepts the US plan, as demonstrated by Japan's experience, is economic chaos and long-lasting depression.

America should stop blaming China's cautious saving for America's reckless spending. This accusation is unfair. To expect China to rapidly appreciate the RMB, at the risk of widespread bankruptcies and social unrest at home, is even more absurd. America should stop externalizing its domestic issues and act in a more responsible way, by reducing the twin deficits, stopping the hazardous liquidity-creating measures, restructuring its own economy and be more open to foreign investors.

In the above three fronts, America is starting a war with unclear targets and wrong methods. Although senior US officials deny that America seeks to sustain its economic recovery by depreciating the dollar, they could not convince the world. America should rethink its recovery strategy and play a more responsible role in preventing the fragile recovery from degenerating into a recession.

When the first G20 summit opened in Washington DC, the world cheered for the advent of a new era in which unilateralism would be replaced by a spirit of cooperation. However, less than two years later, the world finds itself again at a crossroads. Let's hope this time, the world leaders, under the leadership of America, will again move toward coordination and cooperation, instead of relapsing into old ways.