Currency Wars Part II

William Pesek of Bloomberg weighs in (emphasis added):

Currency War Is Solved With One Trip to Bangkok

Oct. 15 (Bloomberg) -- Those finance bigwigs blabbing away in Washington last weekend should visit Bangkok instead.

That’s where the “currency war,” which they naively believe they can avoid with their handiwork, is on display. Just as Thailand was on the front lines of Asia’s 1997 crisis, it’s being flooded by liquidity from Washington, Tokyo and Frankfurt.

On Oct. 12, Thailand removed a 15 percent tax exemption for foreigners on income from domestic bonds, joining South Korea and Brazil in curbing hot-money flows and currency gains. The former risks overheating, the latter threatens exports…

…Think of markets as a giant game of Whac-A-Mole. Officials from Beijing to Brasilia stand at the ready, hammers in hand, to whack down any spike in exchange rates. The trouble is, everyone is whacking at once. When everyone tries to tame currencies simultaneously, there will be few, if any, winners.

…The yen’s mid-1980s surge didn’t magically revitalize the U.S…

…Blaming China for lost U.S. jobs is easy for politicians. But it’s hogwash to say a stronger yuan would end the recession.

China’s main advantage is cheap labor. If you boost the yuan 20 percent, China will still undercut U.S. manufacturers. Since consumers aren’t getting raises and worry about job stability, they want to spend as little as possible for that new refrigerator, sofa or doll house -- products made by China Inc.

Dent China’s export machine, and production will shift to Vietnam, Indonesia, Thailand and Bangladesh. Such nuances aren’t just lost on the average worker in Iowa, but also congressional candidates who seem determined to outdo their competitors with China bashing. They should focus instead on retooling their economy and education system to compete in a future that belongs more to developing nations than to the traditional elites…

…One reason is that the answer to the biggest challenges of our day is structural reform. Currency deals won’t make Americans save more, they won’t get Chinese to save less and won’t make Europe’s economies immediately more dynamic.

Another: We’re past the time when a handful of rich, largely Western economies could call the shots for the rest. We no longer live in an era when there is firm agreement on how the global economy operates and how it should be led. And to merely blame China here is to oversimplify.

…and in another piece (emphasis added):

Scary IPOs Are Price We Will Pay for Zero Rates

Oct. 18 (Bloomberg) -- Prasarn Trairatvorakul struggled for balance as the ferry taking him across a Bangkok river pitched in choppy waters.

“It’s a bit like the world economy these days,” the Bank of Thailand governor deadpanned as he plopped down next to me on a ferry deck chair. “Very hard to control.”...

...This hot money is making waves in Asia. It’s pumping up growth, real estate and stocks and, according to many economists, breathing new life into the “Asia decoupling” narrative. Asia hasn’t decoupled from the West so much as it has mutated into a giant net catching money emanating from Washington, Frankfurt and Tokyo. The result may be huge bubbles, the next wave of which could be dodgy stock offerings...

...It’s not as fun as it sounds for Asian policy makers. They are caught by the biggest economies flooding markets with money and warring over currencies...

...The answer for Asia may be as simple as tightening fiscal policy. That, Eichengreen says, could take some of the heat out of economies being overwhelmed by hot money. Even so, there’s no getting around the fact that loose international monetary conditions are swamping domestic policy steps...

...The good news is that Asian policy makers are fully aware that they are on the front lines of a monetary tsunami the likes of which the world have never seen. The bad news is that with the U.S., Japan and the euro zone holding rates at, or close to, zero and China maintaining an undervalued currency, it’s all too easy for smaller economies to get overwhelmed.

The man manages in a couple of articles to articulate the imbalances in global capital that are plaguing emerging markets right now…as well as the limited policy options available. This is less about a currency war, than a globalised economy that is on divergent growth paths.

There’s two aspects to this – first is the exporting of monetary policy from the US and Europe to the rest of the world. By reducing interest rates to near zero, and engaging in quantitative easing, the developed world central banks are forcing countries with currencies that are linked to either the Dollar or the Euro to almost automatically follow suit to maintain exchange rate parity e.g. Hong Kong with its currency board.

A second aspect is the flood of liquidity that is sloshing about in the banking systems of the US and Europe, all running around in search of yield. As long as the perception of risk is low, or at least stable, a lot of that money is going to head for emerging Asia.

The problem here is basically the same scenario that caused the breakdown of the European Exchange Rate Mechanism in 1993 – economics that are linked, yet are on different growth paths. But I’m also beginning to think that the US in particular (by which I mean the FOMC) has to rethink its monetary policy approach.

Using the traditional tools of monetary policy, where policy changes are transmitted via the banking system, isn’t working – the banks are wary of lending and borrowers are leery of borrowing. In other words, the system is broken, and flooding the system with liquidity is just giving banks and their wholesale counterparts the ammunition to destabilise emerging markets, without necessarily reflating the US economy.

I think in this case the Federal Reserve chairman ought to live up to his nickname – it’s time for “Helicopter Ben” to take his cue. The Fed ought to funnel money directly to consumers, rather than rely on a financial intermediation process that’s stuck.

A lot of the angst in the US right now (leaving aside the unemployment problem) is the twofold hit on savings and house prices caused by the  recession. I think the Fed could do worse than to put freshly printed money in the hands of homeowners and consumers. That addresses the shortfall in savings and underwater mortgages that are weighing on the US economy and consumption spending – and by the by, reduce the pressure on emerging markets from excess liquidity. The Fed could also buy US equities directly, although that won’t help the many low-income workers with underwater mortgages.

Sadly, the opposition on the FOMC means that these options will never see the light of day.

On the other side, there’s Barry Eichengreen’s recommendation that Asian economies ought to tighten fiscal policy – but there’s not much chance of that happening either. Capital controls are the other option, though probably less palatable to investors.