A welcome ceasefire – but not peace

Allister Heath
THERE will undoubtedly be some exuberance in the markets this morning on the back of this weekend’s G20 quasi-deal on currencies. Given that the possibility of currency wars has become an even greater risk to the world than the possibility of a sovereign default, a collective sigh of relief would be perfectly understandable. It would be a mistake to uncork the champagne too soon, however, for the document is long on generalities and desperately short on specifics.

Parts of this weekend’s communiqué admittedly make for reassuring reading. Especially interesting were the sections on agreeing to "move towards more market-determined exchange-rate systems that reflect underlying fundamentals”; the pledge to “refrain from competitive devaluation of currencies”; and the section stating said that persistently large current account imbalances -- to be assessed against indicative guidelines yet to be agreed -- would warrant an assessment by the IMF.

The first two are positive – assuming, that is, that words eventually lead to actions – while the third may be helpful but could easily go wrong. The first quote addresses China’s policy of under-valuing the yuan to help its exporters; the second tackles the perception that the US is deliberately depressing the greenback, most notably against the euro, for example by constantly hinting that more QE is to come; the last demonstrates a growing understanding that excessive current account surpluses have allowed Asian governments to hoard vast amounts of foreign currency reserves.

The communiqué fell short of a new Plaza-style accord to manage the greenback’s decline. But that is a good thing: the 1985 accord was a disaster. It allowed too extreme a dollar devaluation, prompting Tokyo to slash rates in response, fuelling a bubble and bust the Japanese have still not fully recovered from. We should be careful of excessively grandiose plans for the currency markets; they have a terrible tendency to backfire.

The communiqué didn’t include numerical targets for the size of countries’ current account balances, as proposed by America. Yet the absence of any such number is to be welcomed. A country’s current account tallies its trade (exports minus imports), net factor income (interest and dividends) and net transfer payments (foreign aid). It is absurd to try and centrally plan such a complex statistic, little more than an artefact made up by clever economists. A massive current account deficit or surplus may indicate an underlying economic problem – but it is the problem itself that needs tackling, not its manifestation.

There is nothing wrong per se with trade surpluses or deficits; to think otherwise is to fall prey to an age-old mercantilistic fallacy. The purpose of an economy is not to export as much as possible and import as little as possible; the opposite is the truth. We only need to export because we want to import and consume what companies in other countries are able to produce. It may even make sense for some countries to specialise in exporting capital and importing goods.

China’s surplus is only an issue because it is caused by exchange rate manipulation; and because surpluses are being recycled into bonds, bidding up their price and fuelling new bubbles. It is great the G20 is finally beginning to accept this analysis. Yet it has no mechanism for delivering reforms. Let us hope that, for once, reason actually ends up triumphing against all the odds.