ECONOMIC AFFAIRS: by Colin TeeseNews Weekly
Currency war unleashes new world disorder
, February 16, 2013
Those not yet convinced about the problems of an overvalued Australian dollar should consider the following:
Currently, around US$1.05 is needed to buy AUD$1.00. For decades US70 to 80 cents could purchase AUD$1.00. On that basis, we are effectively giving imports from overseas a 20 to 30 per cent subsidy over our domestic industries — manufacturing and farming. We also put our exports industries at an undeserved disadvantage.
The International Monetary Fund ranks our currency as the dearest of the top economies. Back in 2002, a basket of goods costing US$100 in the US could be obtained from Australia for AUD$77.00. In 2012 that same basket cost AUD$161 in Australia.
Is it any wonder our manufacturing industries are shedding labour? Farmers aren’t being helped either. They must try to cope with what are, effectively, heavy subsidies on competing imports. No less important, their best customers — our food-processing industries — are being driven out of business by fierce competition from imports.
Even mining exports to China, once deemed to be recession-proof, are feeling the pressure. Brazil, our biggest competitor, is carefully managing its exchange rate in order to maintain and enlarge its competitive advantage over Australia.
How can this happen? And why is our so-called independent central bank, the Reserve Bank of Australia, not doing something about it?
Conventional trade theory insists that this can’t happen. Orthodox economics tells us that floating exchange rates, and unrestricted trade and capital flows, can’t escape the push and shove of market forces. The resulting corrections will keep the world trade and payments system in rough balance.
But we don’t live in an ideal world, and mere trade theory can’t cope with the way the real world operates. Over the last 25 or so years, a malfunctioning system has pushed world trade and finance into serious and sustained imbalance.
Successful exporting countries, notably China, Japan and Germany, have been able to secure an ever-increasing share of manufacturing exports. On the basis of currency manipulation, the world’s biggest exporters of manufactures have managed to keep increasing their exports and, in the process, gather up most of the world’s currency surpluses. Meanwhile, importing countries, unable to meet the import competition from domestic sources, have been forced to borrow to fund imports of both capital and consumer goods.
As a result, the world has divided into debtor and surplus countries. What the theorists deemed impossible has actually happened. A combination of imprudent bank-lending, and an imbalance of debt and surplus, have destabilised the world trading and payments system to the point of generating the recent global financial crisis.
Regardless of whether the banks are brought into line, debt imbalances are enough to ensure that any recovery from what is already being called the “Great Recession” will be difficult and protracted.
Why was Australia not sucked into this crisis from the beginning? First, because our banks were more tightly regulated; second, because the government took stimulatory measures to maintain levels of domestic spending; and, third, we had a profitable and expanding trade in iron ore and coal with China, whose economy was growing rapidly.
Of course, the system was unsustainable. Our currency, totally exposed to the mercy of global financial markets, followed orthodoxy and was allowed to rise in concert with our booming exports. The effects were not immediate, but gradually an overvalued currency began eating into the health of our domestic economy. Our consumers, too, began to accumulate debt. By contrast, exporting countries which managed their currencies increased exports and accumulated currency reserves.
Our valued connection with China, and the extra export income we had gained, meant that, when the music stopped in 2007/08, we were for a time able to conceal the worst of the impact of the trade and financial imbalances on our economy.
That time has now passed. The point has been reached where major adjustments — not least to the exchange rate — must be made.
Unless both our government and the Reserve Bank are prepared to step out of their ideological straightjackets and deal with the currency problem, those necessary adjustments won’t happen.
Theirs is not an enviable position. Placing a lid on the exchange rate, necessary though that may be, won’t be enough. Fixing all the associated problems created by deregulation will require international co-operation on a scale not seen in the world community in the last 30 years.
Harvard economist Dani Rodrik, whose seminal ideas were discussed in News Weekly last year, has coined the term “trilemma” to describe the inability of countries to pursue economic globalisation (or, as he calls it, economic integration), maintain national sovereignty and enjoy political democracy. One of the three must be traded off to retain the other two. (His latest book, The Globalization Paradox: Democracy and the Future of the World Economy, is available from News Weekly Books).
Many have dismissed Professor Rodrik’s view either as an attack on the idea of global economic integration, or else as an interesting theory of little practical value. This approach entirely misses the point Rodrik is trying to make.
He reminds us that the Bretton Woods system, put together in 1944, which held the world trade and payments system together for 25 years after World War II, was an example of what he calls “shallow” integration — and it actually worked.
Governments under this postwar arrangement retained control over all the important elements of domestic economic policy which impacted on domestic politics — especially trade and import policy and capital flows — but worked cooperatively to keep the system balanced.
Exchange rates were fixed (within agreed bands), and could only be moved in certain specified conditions triggered by domestic policy considerations. Participating countries cooperated to keep trade flows balanced, whereas today countries are engaged in a competitive race for export advantage in which exchange-rate manipulation has become a prominent feature.
Rodrik believes that genuine commitment to international cooperation evaporated with the collapse of Bretton Woods in the early 1970s. Trying to construct a replacement framework in the absence of that commitment has thus far proved impossible. The most obvious example is the World Trade Organisation.
The imperfect operation of the WTO has demonstrated that there is no single path to trade liberalisation appropriate for all economies — for a variety of economic and political reasons — especially in democracies. Many of those which have joined the WTO have discovered that, in doing so, they are committed to following unsuitable policies which seriously limit their national sovereignty, and which can even undermine democratic legitimacy.
The fact that these pressures are surfacing perhaps helps explain why the WTO’s Doha Round of talks, to promote wider and deeper trade policy integration, is stalled.
Though originally welcomed as an essential component of the deregulationist experiment, floating exchange rates, as they currently operate, are now exposed as a serious handicap to economic and financial stability.
Deep integration (i.e., economic globalisation) was premised on the universal acceptance of the idea of free trade, free capital movements and floating exchange rates. The first two were pretty widely implemented; but the third never was. What we got for exchange rates was a hybrid system — some countries floating, many not.
In a competitive global system, the optimistic expectation of widespread acceptance of a loose commitment to float exchange rates was misguided. Without a WTO-type binding agreement, it was never possible. And currency control was far too important to entrust to international arbitration.
And so it was that a fatally flawed version of deep integration limped off, with most of its supporters blissfully unaware that it could not possibly survive. Professor Rodrik reminds us we are now confronting the reality of all that.
The more perceptive nations are now emulating the major exporters and manipulating their currencies to maintain or expand exports levels, or to contain imports.
Popularly this is being called a currency war. It is worth recalling that in the mid-1930s, as the Great Depression bit deeper, nations began erecting import barriers to achieve the same effect. Now, in the time of the Great Recession, we talk of a currency war.
Eighty years ago there was no World Trade Organisation to stop countries erecting tariffs or offering subsidies. Today those avenues have been closed off. Besides, tariffs are no longer relevant in promoting trade or protecting industries.
Controlling exchange rates can do a better job to the same effect. Manipulating currencies is the new way — lowering the value of one’s currency makes exports cheaper and imports dearer. By contrast, allowing the value of one’s currency to soar, as Australia has done, has the opposite effect — making exports dearer and imports cheaper.
In time of crisis, trying to contain powerful countries within the “free trade” straightjacket of the World Trade Organisation won’t work. Binding trade obligations will not be allowed to stand in the way of a country’s national interest. Just as in the 1930s, beggar-thy-neighbour policies are alive and well today. That is the lesson we should derive from today’s currency war.
The trade straitjacket created by the WTO has not prevented nations from going protectionist but rather guided them along a much more damaging protectionist path achieved through currency manipulation. This path has helped wreak havoc on the world economy, and we have only recently woken up to the fact that a new sort of trade war is well underway.
As much anything, this is the message Dani Rodrik is trying to get across.
If Rodrik is right, there is no time to waste. What we urgently need is a new Bretton Woods-type arrangement to manage and regulate the world’s trade and payments system — built around the “shallow” (but far more effective) international integration model and held together by cooperative efforts on the part of participating nation-states.
Sadly, for the moment, anything like that appears beyond our politicians to achieve.
Colin Teese is a former deputy secretary of the Department of Trade.