China's
not the villain if the West tries to debase its debt through
QE By Liam Halligan
| 9:00PM BST 16 Oct 2010
Last
weekend's "currency war summit" ended in dismal
failure. Future historians will wince.
The annual meetings of the International Monetary
Fund in Washington are supposed to generate some kind of resolution.
Instead, all we got was posturing and a slew of pious speeches
saying that "co-operation is crucial".
What is now clear is that some of the world's
leading economies are deliberately debasing their currencies
in order to make their exports more competitive and lower
the real value of the massive debts they owe the rest of the
world.
Tempers are rising, as are protectionist sentiments.
Across the globe, governments are talking about "aggressive
tariff barriers" and "trade retaliation" -
language that hasn't been used by mainstream peacetime politicians
since the mid-1930s.
Yet instead of knuckling-down and addressing
the urgent task of building some kind of an agreement to contain
a fully-blown currency conflict, world leaders last Sunday
urged the IMF only to "study the issues", and "play
a stronger role in monitoring how the policies of each member
state affects the others".
This was a pathetic response. The concluding
statement of the fund's policy-setting committee meekly pledged
to "work toward a more balanced pattern of global growth,
recognising the responsibilities of surplus and deficit countries".
To his credit, even the IMF's own managing
director, Dominique Strauss-Kahn, labelled such language "ineffective".
The governments controlling the IMF simply kicked the tough
conversations into the long grass – postponing them
until the Seoul G20 summit in early November at the earliest.
While policy at the global level is non-existent,
the US and several other "advanced" nations, including
the UK, are in the midst of a radical policy experiment that
is about to get even more extreme. For most of last week,
the dollar fell further on speculation that the Federal Reserve,
having already bought $1,700bn (£1,062bn) of dodgy mortgage-backed
securities and government bonds with newly-created money,
will soon indulge in further "quantitative easing".
As a result, the US currency hit record lows
against the Chinese yuan, Swiss franc, Australian dollar and
the Japanese yen. And, of course, that is just what America
wants.
Ben Bernanke, the Federal Reserve chairman,
continued to fuel speculation that the US is about to unleash
hundreds of billions of dollars more QE money. "There
would appear – all else being equal – to be a
case for further action," he said in a speech on Friday.
Yet America's now blatant policy of trying to print its way
out of trouble, a ploy being copied by others, is far from
proven and could actually make things worse: QE on the scale
now being proposed has never been tried. It is beyond the
realms even of economic theory.
If banks in the US and elsewhere remain reluctant
to lend, Western economies will stay in the doldrums and could
tip back into recession. On top of that, there is a very real
danger that renewed money printing drives up the price of
oil and other commodities - imposing serious damage on the
QE nations, most of whom are importers of such key economic
inputs.
Crude is above $80 a barrel. With the price
of copper and tin soaring, the London Metal Exchange price
index last week hit a two-year high. Commodity prices are
strong - and rising - even though Western demand remains sluggish
because of economic weakness. There are, of course, solid
reasons why the price of oil, metals and other tangibles should
stay firm – not least the on-going rapacious demand
among emerging nations in Asia and elsewhere as they industrialise,
build more infrastructure and their energy-hungry middle classes
continue to grow. On the supply side, too, with the credit
crunch having starved the capital-intensive extractive industries
of cash in recent years, there are fewer mining and drilling
projects about to come on stream.
But something else is going on. International
investors, deeply alarmed by the Western world's wildly expansionary
monetary policy and the related destruction in the value of
paper currency, are starting to park their wealth in assets
"that governments can't print more of". The obvious
manifestation of this is the price of gold, which hit another
record on Thursday. Silver has also just reached a 30-year
high, and is set to scale $25 per ounce.
Aside from precious metals, though, the nightmare
scenario is that QE leads to a spike in the price of oil and
other commodity imports needed to keep the Western world running
- as a result of investors using such assets as an "anti-debasement
hedge". There are signs this is starting to happen. If
the trend becomes stronger, and speculators pile in via commodity-related
price indices and "exchange-traded funds", the result
could be a commodity price run-up that shatters the already
anaemic Western recovery.
Were that to happen, central banks such as
the Fed would huff and puff, spouting populist nonsense about
"clamping down on speculation". But the reality
is that high, and even spiralling, commodity prices are an
absolutely rational response to QE. Such price rises would,
in fact, cause a decline in real incomes in the very countries
printing the money – seeing as commodities and other
tangibles are inputs into the goods and services we buy. These
deeply counter-productive QE outcomes could very easily come
to pass. Yet across the Western world, among politicians and
media commentators, there is barely a whimper of protest about
this reckless and unprecedented policy.
Attention is focused, instead, on China and
its "over-valued currency". Like a pantomime villain,
the Peoples' Republic is blamed for the West's economic woes.
In August, America's trade deficit surged to $46bn, its deficit
with China alone hitting a record $28bn. But to listen to
most US politicians, you'd think such numbers had nothing
to do with the fact that China makes a lot of goods the world
wants and US exports in many sectors have become uncompetitive.
Not least due to America's QE, the yuan has
appreciated around 3pc against the dollar since June - when
Beijing signalled an end to its "currency peg" regime.
However, with crucial mid-term elections looming in early
November, US legislators and union bosses are urging President
Obama to take tougher action, blaming "Chinese trade
distortions" for the loss of "millions of US jobs".
China is hitting back. A government spokesman
argued on Friday that it's "totally wrong to blame the
yuan for the Sino-US trade imbalance" and urged America
not to make China its "scapegoat". Imminent US legislation
imposing retaliatory tariffs on China is almost certain to
breach World Trade Organisation rules. Unless this stand-off
is defused, it can only end badly.
So expect "currency manipulation"
to be top of the agenda at the G20 summit. But don't expect
much in terms of resolution. As South Korea's President Lee
Myung-Bak says: "If the world fails to reach agreement
on foreign exchange policy and insists on its own interests
it will bring about trade protectionism and cause very difficult
problems to the global economy". Then again, South Korea
has itself intervened heavily in currency markets in a bid
to boost its exports.
The QE end-game is impossible to foresee.
While the dollar is falling for now, if commodities balloon
then correct sharply the dollar itself could spike. Having
said that, the long-term trajectory of the US currency must
surely be down. The irony is that by implementing yet more
QE, America may not do itself much good. It could succeed,
though, in imposing chaos on the rest of the world.