At their November meeting inSeoul, the leaders of the G20 nations once again patted themselves on the back for their massive efforts to stabilize the global economy since the 2007–08 financial panic. The rest of the world might be forgiven for not sharing their enthusiasm.
Leaders might swear in public to work together, but at home they continue to wall off their own economies against immediate dangers—with no concern for the consequences next door. The U.S. Federal Reserve is flooding the still-struggling U.S. economy with dollars, many of which end up chasing more promising returns in emerging nations, threatening to overvalue their currencies, create asset bubbles, and price their goods out of world markets. Beijing shows no signs of letting the yuan appreciate significantly, a virtual guarantee that Chinese exports will keep gaining market share all over the world. Smaller nations brace for the fallout, which includes declining exports and pressure on companies and jobs. Recently Alan Bollard, Reserve Bank governor of New Zealand, put it succinctly: “When elephants make love, or war, the grass gets crushed, and that’s the risk smaller economies face in this situation.”
So it was that Brazilian Finance Minister Guido Mantega—alarmed as the Brazilian real rose to near record highs against the greenback—dubbed this the era of currency wars: each nation tries to keep its own economy going, in part by managing the exchange rate and intervening in the markets to keep a step ahead of its neighbors. Already, scores of nations are taking aggressive measures to try to stanch the flood of incoming dollars and shore up faltering industries. Central banks everywhere are moving beyond merely buying up excess dollars to outright intervention in the exchange markets to stop their currencies from spiking against the dollar. Taiwan and Thailand recently imposed capital controls on foreign investments in their bond markets. Brazil tripled its tax on international financial capital from 2 to 6 percent. Worryingly, blaming the foreigner is back in fashion. One way or another, everyone ends up a combatant in the currency wars.
But it could get worse. Without a truce, South African Finance Minister Pravin Gordhan recently warned, a full-blown trade war could break out, as each country seeks to compensate the damage that a rising currency causes at home by hurling up trade barriers against others believed to be resorting to so-called monetary dumping.
So much for the symphony of global consensus. The expected new world of cooperation has now turned into a nightmare of accusations of exchange-rate manipulation, beggar-thy-neighbor policies, and currency wars.
What can be done? It is clearly impossible for all countries to devalue their exchange rates at the same time. The answer here is the same one that the G20 has already reached but not yet acted upon. Some international cooperation on exchange rates is necessary, but that alone will not do the job. At the national level—especially in the mature economies—there must be more emphasis on the long-term reduction of deficits as well as structural reforms and investments (such as in education, innovation, and infrastructure) that raise productivity and growth. But that is unlikely to happen soon in any broad and coordinated way, so the danger is in fact that currency war escalates into trade restrictions and more extreme controls of capital flows. Confidence would remain low, and a vicious circle of bad policies could ensue. In this context a relapse of the global crisis cannot be ruled out. In all likelihood it would be worse than the original version.
Unfortunately, this high-anxiety momentseems like the new normal in international relations. The sobering fact is thatin recent years the most important attempts to forge global cooperation have ended in failure. The Doha Round of trade negotiations has languished inconclusively for years, the Copenhagen discussions on climate change ended with anodyne statements, and the many attempts to overhaul the regulations of the international financial system have fared little better. In hindsight, even the measures undertaken at the start of the global financial crisis were not so much a show of cooperation as it was each individual country pursuing its own domestic objectives. It just so happened that, at least for a while, everyone was pursuing the same objective: avoiding a deep recession.
This means that for now we are left with more of the same: each country will, for the most part, continue to fend for itself. If the history of crises in the emerging world tells us anything, it is that to succeed in dealing with a crisis it is necessary to blend short-term firefighting—of which nations have now done plenty—with reforms that address key long-term problems. This means the advanced economies must now solve their structural problems, boost productivity, and reform their economies to promote growth, but above all tackle unsustainable government deficits and debts. If and when this is done, things will turn out all right. If not, watch out—then the currency wars will be the least of our troubles.
Fraga is the chairman of Gávea Investimentos and a former president of the Central Bank of Brazil.