u.s plays with currency fire

  1. 3,683 Posts.
    lightbulb Created with Sketch. 13
    Although the turmoil it created has subsided somewhat, the statement by G7 finance ministers that global currencies should be free to fluctuate is an important one, one that will have far-reaching effects not just for the United States and Asia but for Canada as well. While the United States might like to think of itself as the puppet master, pulling strings in order to get certain currencies to do what it wants (including its own), currencies -- and those who trade them -- are notoriously fickle, and not inclined to take orders from anyone.

    The impetus for this currency talk is obvious, at least from the U.S. point of view. The Bush government, heading toward an election, is increasingly anxious about two things: the country's gargantuan trade deficit, and a conspicuous lack of new jobs, despite what appears to be an emerging economic recovery. They're hoping to solve both these problems by talking down the U.S. dollar and talking up both the Japanese yen and the Chinese yuan. But nothing is ever quite that simple in the global currency game.

    One of the key potholes in the U.S. plan is that the main target of the Group of Seven message isn't even part of the global financial body, nor is it likely to be listening to the currency advice of the G7 finance ministers. That country is China, a nation whose low-cost manufacturing base has made it "the world's factory floor," as some economists like to put it. Sometime last year, the U.S. trade deficit with China outgrew that between the United States and Japan, and that has made American manufacturers a very unhappy group.

    As U.S. companies see it, China manipulates its currency in order to keep it artificially low, and this in turn makes its goods more competitive than those produced in the United States. The manipulation comes because the yuan (which is known inside China as the "renminbi" or "peoples' currency") is pegged at a rate of 8.28 to the U.S. dollar. For the past year or so, the United States has been putting pressure on China to let the yuan "float" or fluctuate, which economists believe would cause it to move higher relative to the dollar.

    China, however, has shown no inclination to do so, primarily because keeping the yuan low has produced tremendous economic growth for the developing nation (as well as U.S., Canadian and European companies that have moved their manufacturing operations to China), and moving it higher solely to benefit the United States isn't a particularly attractive option. China also probably feels singled out, since Japan manipulates its currency too -- but doing so actually helps the United States, and therefore is seen as acceptable.

    In order to keep the yen low relative to the U.S. dollar, Japan buys billions and billions of dollars worth of U.S.-denominated debt, which provides a ready market for U.S. government bonds -- and the United States is selling more and more of those as a result of its gigantic federal deficit, which will likely approach the $500-billion (U.S.) mark next year. Japan is the single largest holder of U.S. debt with about $445-billion worth, although China is moving up rapidly. It's currently the third largest with about $126-billion.

    Some economists say the United States is playing a risky game by trying to get China and Japan to let their currencies fluctuate, in part because of the enormous U.S. debt position the two countries have. What if they no longer have to buy as many billions worth of T-bills to keep their currencies where they are? That would not only make it more difficult to finance the federal deficit, but it could lead to higher interest rates. "If interest rates go up too fast, that will put the brakes on the housing sector," said Rajeev Dhawan, an economist at Georgia State University. "That could mess up the whole recovery."

    But the U.S. government is more concerned about its own currency, and getting its value down, on the assumption that this will make U.S. goods more competitive and in turn will create jobs. "The administration clearly wants a weaker dollar, but they will never say it publicly," says Sung Won Sohn, chief economist at Wells Fargo. And if the United States is successful in this attempt to talk the value of its dollar down, countries with higher interest rates will see their currencies rise, and that includes Canada.

    Several Canadian economists have warned that this trend could see the Canadian loonie rise as far as the 80-cent level over the next year. While that is sure to make snowbirds and importers happy, since it will reduce their costs, a rapid rise in the dollar on top of the rapid rise we've already seen in the past year would hit some export industries where it hurts, at a time when the Canadian economy is already stumbling somewhat. Growth in the United States may make up for some of that, but then again it might not.

    In any case, Canada isn't likely to be the only one in harm's way if the U.S. campaign is successful. "Playing with currency is like playing with fire," said Edwin Truman, an economist with the Institute for International Economics, after the statement by the G7 on Tuesday. "Fire plays a useful purpose. It can keep you warm. But you can also get burned."

arrow-down-2 Created with Sketch. arrow-down-2 Created with Sketch.