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Currency wars, the circular firing squad

The value of a dollar
By Alan Kohler

It has been a week since Brazil's finance minister, Guido Mantega, declared that we are in the midst of an international currency war and that Brazil was joining in to try to keep its currency from appreciating further.

That led foreign exchange traders to immediately bet $US14 billion that the Brazilian real will, in fact, keep rising.

Meanwhile central banks and governments in Japan, Colombia, Thailand, Poland, Taiwan, Russia, Peru, Mexico, Korea, South Africa are now either intervening directly in foreign exchange markets to try to force their currencies down, or talking about it.

China, of course, intervenes simply and directly by pegging the yuan to the dollar. American authorities are effectively intervening by holding interest rates at zero and talking about printing more money.
Everyone is worried about exchange rates except Australia. The Australian dollar has appreciated 50 per cent since March 2009 and 20 per cent since June this year and is this morning sitting comfortably above 97 US cents, but there has not been a peep from either politicians or central bankers.

Australia is an island of laissez-faire calm in a frothing sea of competitive devaluation. Why? Because we have neither a demand deficit nor high unemployment.

As 12-year Reserve Bank staffer and now HSBC's Australian economist, Paul Bloxham, said in my interview with him on Inside Business yesterday, the RBA likes the appreciation of the Australian dollar because it helps reduce inflation.

"Increasing interest rates is hard work. If the exchange rate does some of the work for you in terms of slowing some parts of the economy down, I think that's regarded as a good thing."

And Australia's politicians are kept quiet by low unemployment. Brazil's unemployment rate has fallen steadily from 12 per cent in 2004, but it is still an uncomfortable 7.4 per cent.

The world is finding that without rampant credit growth, through which demand is borrowed from the future, it is very difficult to create enough work for people supplying domestic markets. For China make that rampant exports, supported by rampant credit growth in the US.

As a result, the economic crisis that began with the credit collapse of 2007 is entering a new phase in which countries are trying to steal demand and employment from each other, instead of from the future as they did before.

Martin Wolf wrote in the Financial Times and Business Spectator last week that as a result of the crisis developed countries are suffering from chronically deficient demand.

"US, Japan, Germany, France, the UK and Italy... are now operating at up to 10 per cent below their past trends."

Those countries are now trying to use the demand of other countries to make up the gap through exports. The simple way to achieve that is by debasing the coinage. As a result money is pouring out of the developed world and into emerging countries, pushing their currencies higher. They are now intervening to reverse that.

China's peg means that while the US dollar may depreciate against the yen, euro, Australian dollar, Brazilian real and so on, it won't depreciate against the yuan.

That, in turn, means that something more direct may be needed, such as tariffs or embargoes targeted at China. In other words a trade war, not a currency war.

As Alen Mattich wrote in the Wall Street Journal, competitive devaluation is like shipwrecked sailors trying to keep their heads above water by climbing on each other's shoulders.
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