The Specter of Protectionism World Faces New Wave of Currency Wars

An American bill imposing punitive tarifs on countries that undervalue their currencies is set to unleash a new trade war between the US and China. But in fact the whole global currency system is in a state of jeopardy. As confidence in the dollar drops, private investors are putting their faith in gold. By SPIEGEL Staff.

The US accuses China of undervaluing its currency.

The US accuses China of undervaluing its currency.

At first glance, the new bill sounds perfectly innocuous. "H. R. 2378 -- Currency Reform for Fair Trade Act" was on the agenda of the US House of Representatives late last Wednesday afternoon. Fair trade -- who could object to that?

But as the representatives started debating, it didn't sound harmless anymore. In fact, it sounded like war.

"International trade is a high-stakes, cutthroat business. And every time we simply talk, the other side acts. And every time they act, an American loses a job," said Xavier Becerra, a Democratic congressman from California.

Timothy Murphy, a Republican from Pennsylvania, went one step further: "We are about to lose our position as a global leader when next year China overtakes us as the biggest manufacturer in the world. The trouble is that China has never really accepted the basic rules of fair trade."

Democrat Linda Sanchez from California argued: "Opponents say that this bill will start a trade war. I say, we are already in a trade war. And China is using cannons and we're standing here shooting (air gun) pellets."

Verbal Attacks

There was one verbal attack right after the other, for roughly an hour. Speaker after speaker condemned the alleged "currency manipulators" from China who supposedly subsidize their products by keeping their currency artificially low. They all want to see H. R. 2378 passed into law.

A closer look at the fine print also reveals that the draft legislation is far from harmless. The bill calls for the US Department of Commerce to start imposing -- even without approval by US President Barack Obama -- punitive tariffs on certain countries. The initiative specifically targets countries that have "a fundamentally undervalued currency," "persistent global current account surpluses" and very large currency reserves -- in other words, China.

The bill passed the House by a vote of 348 to 79. "This is a stronger message than any previous one," says Nicholas Lardy from the Peterson Institute for International Economics.

Rediscovering Protectionism

The trade conflict between Beijing and Washington has thus entered a new, acute phase. One month before the high-stakes mid-term congressional elections, America's representatives, alarmed by nearly 10 percent unemployment and a gloomy economic outlook, have rediscovered an old friend: protectionism.

At the same time, they have pointed the finger once again at their favorite enemy: China. They are demanding that China finally adjust its currency so that Chinese products are no longer much cheaper than those manufactured by its US competitors.

Things are heating up in the conflict between the US and China: verbally, legally and politically. The economic power of the 20th century wants to cut the 21st century's economic giant down to size. The question is whether it is even still strong enough to do so -- and whether such a conflict won't end up harming everyone.

For a long time, the US economy has been dependent on cheap products made by the Chinese and on their currency reserves that bolster the value of the dollar. Until now, both sides have benefited from this system. One side lived beyond its means and paid with printed pieces of paper called dollars, the other side used this paper to purchase US government bonds, allowing it to accumulate huge currency reserves.

But things can't continue like this forever. Imbalances in world trade are growing increasingly large, and the global currency system is getting out of control.

American Hypocrisy

There is, however, also a fair amount of hypocrisy behind the latest American initiative. Nobody has controlled the currency markets as much as the US has in the past. The US Federal Reserve still continues to print dollars to finance skyrocketing government debt. The fact that this erodes the value of the US currency is something that the Americans seem not to care about. Of course, this makes imports into the US more expensive, but it also makes American exports cheaper and enhances the competitiveness of US companies.

Ultimately, though, exchange rates reflect the interconnectedness of today's world. When one side wins, the other loses, and vice versa. Recently, the euro suddenly rose, even though only a few months ago the financial world was speculating over the decline of the European common currency -- and the problems of the euro-zone countries have by no means been solved. The European Central Bank under President Jean-Claude Trichet is still purchasing government bonds from ailing euro countries to help maintain their value.

Nonetheless, risk premiums for Irish government bonds soared to new heights last week as the cost of bailing out the country's troubled banks rose to a massive €45 billion. In a number of euro-zone countries, tens of thousands have taken to the streets to protest planned austerity measures, giving rise to doubts over whether the proposed restructuring of state finances in these countries will actually succeed. That would normally be enough to drag down the euro -- if the economic outlook in the US weren't even gloomier.

Upside Down

Japan is also facing major difficulties. The economy still hasn't managed to recover, and the country continues to suffer from deflation and enormous government debt. Normally, all of this would pull down the value of the Japanese currency, but the exchange rate of the yen to the dollar is also rising because the Chinese, out of fear that the US currency will continue to fall, are increasingly investing their currency reserves in yen as well.

Nothing is as it should be on the global currency markets. It seems as if the world has been turned upside down -- and has become very dangerous. Indeed, for better or for worse, the well-being of entire countries depend on the value of these currencies, meaning that instability on the currency markets also threatens the structure of the global economy.

If the exchange rates are manipulated, imbalances increase and problems become more marked -- until they ultimately escalate. That would threaten to spark a currency crisis that could bring down entire economies.

Sucked into the Maelstrom

By itself, no country or currency zone could escape the maelstrom of such a crisis, as all countries are interconnected via their exchange rates. This is partly what makes it so dangerous when a country devalues its currency to boost its economy. If one side secures such a competitive advantage for itself, it automatically puts the other side at a disadvantage. If the other side reacts with a devaluation, this triggers a downward spiral where everyone is the loser. Economists call such a fateful development a deflationary spiral, a term from a dark, bygone era of economic history. It's a term which suddenly appears to be relevant again.

Brazilian Finance Minister Guido Mantega is already talking about an international currency war. "The advanced countries are seeking to devalue their currencies," Mantega said in a speech last week. "This threatens us because it takes away our competitiveness."

Brazil intends to resist a looming revaluation of its currency. Earlier, Japan massively intervened on the currency market.

Switzerland also sees itself as a victim of the weak euro and dollar. A great deal of capital is flowing into the country, threatening the competitiveness of the alpine nation's export industry. Time and again over the past few months, the Swiss central bank has purchased euros in an attempt to clip the wings of the soaring Swiss franc.

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esperonto 10/05/2010
1. A Modest Proposal for World War
I read another article about this recently. I find it intriguing how currency fluctuations occur globally, and how nations play games with values. I also wanted to know about this because I am a socialist, and must therefore understand all things relevant to the rise of socialism. In that article, the writer speculates that this will not just cause a trade war, but a World War. One quote I found funny was making fun of Robert Samuelson at the Washington Post, who wrote an article about it being better to have a trade war than Chinese Ascendancy. The WSWS writer mockingly renamed Samuelson's article: "A modest proposal for world war”. This is his original article: My personal views is that international trade is extremely bad all around. My view is not patriotic at all. Quite the opposite, I believe international trade to be inherently malicious. I have bought things more expensively sometimes simply because they come not from overseas. I think free trade is ruining people's quality of life and causing international stress on workers, while rich people seem to glide on the energy created by the stress, apparently having a blast and eating cavier.
esperonto 10/05/2010
2. Liberty Dollar
Interesting, the liberty dollar website has been removed by a court order! If you go to the actual site it says removed by court order: The Second Vermont Republic is also making its own money similarly. This is part of a secessionist movement and can be considered eccentric to Vermont, but highly viable as they elaborate on the kitschy idea of a new green mountain nation: The neat thing about that fantastically shiny green Vermont flag is that it looks similar to the flag for the Esperanto movement. Some foreigners who are still in awe of the USA would not be able to fathom an American state declaring independence. The red white and blue flag of American imperial power holds their minds completely with its archetypal character, the small square in the upper corner in blue with white stars and candy can stripes seems indestructible, but after a few generations in the states, it seems relatively uninteresting to even be American. Breaking off from the USA is more exciting, especially given the control of the Federal Reserve and the lack of other lands to immigrate to. The happy green flag and shiny silver coin with socialist icon Scott Nearing is extremely appealing. Like old American quarters, it is silver. My grandfather from Philadelphia said that back in the old days, people used to scrape the ridges off the edges of the silver American quarters and save the silver, then smelt and sell it.
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