That was quite a speech by Ben Bernanke in Frankfurt, Germany today, blame being laid at the feet of just about everyone but the U.S. central bank for the growing problems in the global economy and international monetary system that, in the end, he concludes has a structural flaw whereby exporting countries are not forced to correct their trade surpluses.
While there is no mention of a “savings glut” (whatever happened to that, anyway?), there is clear finger pointing at China and other Asian nations as the proximate cause of the world’s troubles, namely, their refusal to let their currencies appreciate against the U.S. dollar.
The exchange rate adjustment is incomplete, in part, because the authorities in some emerging market economies have intervened in foreign exchange markets to prevent or slow the appreciation of their currencies. The degree of intervention is illustrated for selected emerging market economies in figure 8. The vertical axis of this graph shows the percent change in the real effective exchange rate in the 12 months through September. The horizontal axis shows the accumulation of foreign exchange reserves as a share of GDP over the same period. The relationship evident in the graph suggests that the economies that have most heavily intervened in foreign exchange markets have succeeded in limiting the appreciation of their currencies. The graph also illustrates that some emerging market economies have intervened at very high levels and others relatively little. Judging from the changes in the real effective exchange rate, the emerging market economies that have largely let market forces determine their exchange rates have seen their competitiveness reduced relative to those emerging market economies that have intervened more aggressively.
Though no names are mentioned in the text, the culprits are clearly identified in Figure 8, a graphic that is reproduced below.
That would be, in order of culpability for the world’s troubles, Singapore, Hong Kong, Taiwan, Thailand, and, of course, everyone’s favorite currency manipulator – China.
(Click to enlarge)
Why are these countries doing what they are doing?
It’s not because they’re looking to avoid the late-1980s fate of Japan where a rapid currency adjustment led to the biggest financial bubble the world has ever seen. It’s because they are backward mercantilists who don’t see the bigger picture.
Given these advantages of a system of market-determined exchange rates, why have officials in many emerging markets leaned against appreciation of their currencies toward levels more consistent with market fundamentals? The principal answer is that currency undervaluation on the part of some countries has been part of a long-term export-led strategy for growth and development. This strategy, which allows a country’s producers to operate at a greater scale and to produce a more diverse set of products than domestic demand alone might sustain, has been viewed as promoting economic growth and, more broadly, as making an important contribution to the development of a number of countries. However, increasingly over time, the strategy of currency undervaluation has demonstrated important drawbacks, both for the world system and for the countries using that strategy.
And, interestingly, he concludes with a reference to how a similar structural flaw in the gold standard led to the Great Depression:
As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new. For example, in the somewhat different context of the gold standard in the period prior to the Great Depression, the United States and France ran large current account surpluses, accompanied by large inflows of gold. However, in defiance of the so-called rules of the game of the international gold standard, neither country allowed the higher gold reserves to feed through to their domestic money supplies and price levels, with the result that the real exchange rate in each country remained persistently undervalued. These policies created deflationary pressures in deficit countries that were losing gold, which helped bring on the Great Depression. The gold standard was meant to ensure economic and financial stability, but failures of international coordination undermined these very goals. Although the parallels are certainly far from perfect, and I am certainly not predicting a new Depression, some of the lessons from that grim period are applicable today. In particular,for large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account.
That’s you China!
So far, there has been no response in the Middle Kingdom. They seem to be a bit busy at the moment hiking bank reserve requirements and interest rates while trying not to make markets plunge too much and getting ready to roll out price controls.
Disclosure: None
