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JEONG Young-Sik

No Bet on a Currency War

JEONG Young-Sik

Oct. 15, 2010

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The architects of the G20 Seoul Summit are scrambling for ways to resolve the global currency dispute before it overwhelms the meeting's agenda but the factors surrounding the feud create a tough task in changing attitudes before the November gathering.

Stimulus measures and monetary expansion have largely been exhausted so nations have fewer and fewer policy tools available. Thus, exports are seen as a panacea to jobs and growth. Since the World Trade Organization bans member nations from imposing unilateral duties, a devalued currency is in the interest of countries to make their goods price competitive in foreign markets.

This puts advanced nations at odds with emerging economies. The former, beset with sputtering domestic consumption, badly need to bolster exports while the latter, who have generally recovered from the global financial meltdown, aim to sustain their export-driven growth.

In the backdrop is a fundamental debate about imbalances in the global economy. The US blames its trade deficit on a devalued Chinese yuan but China rejects the notion that its currency is the root of global imbalance. Rather it blames the profligacy of US consumers and policymakers. Meanwhile, politics is stoking the rhetoric between the No. 1 and 2 economies.

November mid-term elections in the US are prompting Democrats and Republicans to target China to convince voters they will protect their economic interests. On the other hand, Chinese authorities are in no hurry to see the yuan appreciate quickly. A much stronger yuan would weigh down China 's economic growth due to its high dependence on exports and the significant role foreign-invested companies play in the economy. Also, past events show if it serves China's interests to react to outside pressure, methodical, measured steps are preferred, not a dramatic, swift move.

For other nations, they too may harbor misgvings about China 's currency policy but they also are being affected by record-low interest rates of the US and other beleaguered economies. The low rates are spurring capital flight, so called "hot money," to higher-yielding nations, driving up the local currency value in Brazil and Asian export powerhouses, including Korea .

With every nation clinging to growth levers and trying not to be a big loser to weakened currencies elsewhere, G20 organizers will have trouble finding room for compromise. Expect tension over currencies to run deeper for the time being. However, the currency fight should stop well short of turning into a full-blown currency war. Above all, the US and China do not want the conflict to get out of control. The US is concerned about China unloading its massive cache of US Treasury bonds, and Chinese authorities have to cautious about being so unbending that Washington officially declares China a currency manipulator, which would threaten its presence in the US market. A compromise such as tacit agreement between the US and China or international coordination is more probable than a series of mutually destructive trade barriers or China being named a currency manipulator.

Eventually, any international cooperation will be similar to the G7 agreement in Dubai 2003, when the US persuaded its fellow G7 members to support more flexibility in foreign exchange rates. The US aim was to get multilateral support in pressuring China to appreciate the yuan. Moreover, the Chinese yuan is a semi-fixed foreign exchange rate, not an international currency, making it difficult for countries besides China to induce yuan appreciation through market intervention. In addition, it is not easy for countries to weaken their currencies through intervention due to the massive volume of worldwide currency exchange transactions.

Less likely is an agreement similar to the 1985 Plaza Accord, which depreciated the US dollar in relation to the Japanese yen and German mark. These countries' currencies were floating foreign exchange rates, making it relatively easy to coordinate in adjusting currencies. Foreign exchange transaction volume was also lower than now, while favorable stimulus means were in place, making it easier for a US-led international agreement.

In the short term, the currency conflict will increase volatility of major global currencies, but in a longer term the dollar will gradually weaken due to international coordination and changing fundamentals. The Chinese currency is expected to appreciate moderately against the US dollar.

As for the Korean won, it will appreciate more than the yuan since Korea has a floating foreign exchange rate system in contrast to China and Taiwan . That would raise concerns the export-dependent Korea 's economy and financial market stability. Inflow of foreign investments taking advantage of foreign exchange profits and an eventual outflow may raise volatility in Korean financial markets. Financial authorities need to stabilize foreign exchange markets and take preemptive measures for potential heightening trade conflict. Also crucial is management of short-term capital flow and strengthening of foreign exchange soundness supervision to prevent market volatility.

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