The View from Europe
By David Jessop 

Currency war may damage Caribbean growth

For months there have been global mutterings about an impending currency war between the world’s major economies. 

So serious has this possibility now become and the associated danger that it might spark a global trade war, the International Monetary Fund’s Managing Director, Dominique Strauss Kahn, recently told the Financial Times:  “There is clearly the idea beginning to circulate that currencies can be used as a policy weapon ....Translated into action, such an idea would represent a very serious risk to the global recovery.... Any such approach would have a negative and very damaging longer-run impact.”

Put simply, what is happening is that emerging and developed economies alike have begun to seek ways, through the value of their currencies, to maintain or enhance their global competitiveness relative to each other in order to emerge from recession. To achieve this they are trying to ensure that the value of their currency remains low in order to increase exports, and to maintain or develop their industrial base and levels of employment. 

Although these measures are intended to defend the domestic economy they reflect the continuing process of rebalancing that is taking place in the global economy. As a consequence, while the principal protagonists in the currency war have up to now largely been China and the US, increasingly Brazil, India, Japan and the European Union and others are having to act to defend their interests. 

In Brazil’s case there have been suspicions for a while that as a matter of policy its Government has been taking action to hold down the value of the Real to protect its export competitiveness. Brazil believes the developed world is seeking ways to devalue their currencies in relation to emerging nations in an attempt to sustain and boost manufacturing and employment as they struggle to create growth. 

In an apparent confirmation, Brazil’s Finance Minister, Guido Mantega, made clear that Brazil will respond to any actions to revalue currencies by taking steps to drive down the value of the Real which has been strengthening in recent months largely as a result of his nation’s continuing economic growth and the consequent influx of foreign investment and associated currency speculation.

In the case of China there has been concern for some time in the US and other developed nations that Beijing has kept the value of the Renminbi artificially low in order to maintain export led growth, only recently  accepting with reluctance that its currency should slowly appreciate in value by relaxing its unofficial peg to the dollar. 

Although there are not as yet signs of a full scale currency war, the US has gradually been increasing its public rhetoric by describing the Chinese currency  as being ‘significantly undervalued’ and more recently still, Japan has intervened  in global currency markets to drive down the value of the yen after it hit a 15-year high against the dollar. 

The danger in all of this is that while governments continue to be cautious, there is growing desire for action among legislators in developed and emerging nations from Spain to Thailand of the domestic economic and social implications of a global currency realignment. They fear that artificially low currencies in emerging economies will give economic advantage to nations such as Brazil and China to penetrate their markets in ways that will terminally damage older manufacturing industries and cause economic growth at best to be sluggish.

As a consequence there are the first signs of a desire to return to protectionism as nations driven by such concerns begin to explore options to pass laws that will erect trade barriers. 

Already the US Congress, conscious too of the November mid-term elections, is considering legislation that would have the effect of threatening China with tariffs if it does not allow the Renminbi to appreciate. 

Responding, the Peoples Daily, the official voice of the Chinese Communist Party, reflecting the increasingly strident  anti-US rhetoric of the US Government, has suggested that if the US Congress were to pass the bill it would be  a new example of the United States seeking to ‘embrace protectionism through legislation’

As this is being written participants in the IMF’s annual meeting are gathering in Washington. There the issue of an impending currency war and the danger that it might lead to protectionism and a trade war, will be a primary focus although any consensus on what to do is not thought likely. 

All of which potentially presents problems for the Caribbean. 

Without exception its currencies are tied to, or float against, the US Dollar. Most of its export and tourism earnings are bound up with the US or Europe and the region has become, for the most part, economically dependent on visitor arrivals from the same developed nations that are amongst the slowest to come out of recession.  This is in contrast to the region’s near neighbours in Latin America that have used the past decade to diversify their international trading partners and investment relationships  to include  China and nations in Asia, through having a much wider range of offerings and most notably, being able to develop new markets for their agriculture and minerals. 

If as seems likely it will be China with its huge dollar holdings and investments in the US that in the coming years brings about a rebalancing of global currency and trade, the Caribbean with its small economic base, high levels of indebtedness, and deep economic ties with the US and Europe, may well suffer the same relative economic decline that the US and Europe now face.

If this is not to happen, action in real time is required to rapidly diversify the region’s tourism product and airlift, to reduce food import bills through developing agriculture to meet domestic demand and to stimulate a reduction in energy costs. 

David Jessop is the Director of the Caribbean Council and can be contacted at [log in to unmask]
Previous columns can be found at www.caribbean-council.org
October 8th, 2010