Sunday, November 21, 2010

The failure of the G-20

After Toronto which marked a turning point toward fiscal austerity, the G-20 in Seoul focused on the so-called war of currencies.  The 4-page communique stresses the importance of "re-balancing" the global economy, "coordinating" policies and refraining from "competitive devaluations". Not a single word about the reevaluation of the yuan nor on the recent moves of the FED to inject money in the US economy (which reduces interest rates and renders the US market less attractive for global investors thereby lowering the value of the dollar).

China  and the US are the two big players in the current war of currencies. Neither of them is ready to make concessions. Other nations try to reduce the value of their currencies to stimulate exports and therefore create jobs. So the real problem is not just about global imbalances; it is mainly about imbalances between the US and China. In the US, income inequalities are rising dramatically, with more income concentrating at the top 10% and this reduces the relative income of the American middle class. This means more pressure on exports to fill the gap.

In China, an increasing share of income goes to the productive sector rather to Chinese consumers - just like Germany. this reduces the relative income (in terms of purchasing power) of the Chinese relative to scale of domestic output produced by the Chinese economy. This also means more pressure on exports to fill the gap.

Targeting currencies is not effective to stop trade imbalances. A reevaluation of the remimbi will have an effect on trade balance if China responds by reducing real interest rates or expanding credit - which in fact it did after the reevaluation of the remimbi in 2005 and which japan did after the Plaza accord. The expansion of cheap credit offset the impact of the appreciation of the currency and the trade surplus continued to grow. It would be much more effective to target current account imbalances to re-balance the global economy.

The broad agreement on global recovery is meaningless. The truth is that more needs to be done to ease tensions that are moving the global economy closer to the edge of irresponsible protectionism. The key responsibility rests with China and the US, and any move towards a new monetary order will depend on their respective economic policies.

1 comment:

  1. P.S: I recommend this reading: