Currency Wars in Contemporary Times

BSP‐UP Professorial Chair Lectures

LECTURE NO. 6 Currency Wars in Contemporary Times

Dr. Florian Alburo BSP UP Centennial Professor of Foreign Trade

Currency Wars in Contemporary Times Florian A. Alburo Center for the Advancement of Trade Integration and Facilitation 249 School of Economics University of the Philippines Diliman Quezon City 1101

Outline • Introduction • Historical Brief • The Great Recession: Summary of Varying Views • Shadows of Currency War • Weapons of War and Subtle Impacts • Collateral Damage and Direction

Historical Brief • The Great Depression – the immediate reference on currency wars • Manifested by competitive devaluations and protectionism (a tariff war) • Usual interpretation – combination of protection through tariffs and frequent devaluations caused the drastic decline of output and trade • Historians and economists differ in the emphasis of interpretation 3

• Usual interpretation – two dichotomous events )The devaluations (gold abandonment) were at the expense of other countries )Passage of the Smoot-Hawley Tariff Act in the US triggered tariff wars between US and UK • Dichotomy reflected in institutions created at Bretton Woods – IMF ensuring fixed but adjustable exchange rates and GATT to liberalize trade and avoid protectionism • Great Recession of 2008-09 triggered revisits to the Great Depression 4

• New research uncovers more interesting and coherent views of the Great Depression )Both behavior of currency devaluations and tariff increases intricately related; )Motivations behind currency wars were not to gain competitiveness )Institutions created to prevent another great depression inherently inconsistent from a misreading of history

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Countries behaved differently according to the degree of Adherence to the gold standard – those abandoning gold or with depreciated currencies tended to have lower tariffs And faster recovery (percent change in industrial output)

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• “…competitive devaluations misrepresents historical experience…” (Irwin 2011) • Large jump in exchange rates were not to give exporters market gain but to maintain gold parities or depreciation when final exit happens • Tariff wars not intended to shield domestic producers from competition but defend the gold standard • With flexible or floating exchange rates, misalignments have repercussions on commercial trade and negotiated tariffs 7

• Too early to write finis to new research --• Not true that countries that gave up on gold did not impose tariff restrictions – UK did after abandoning gold in 1931; US did after gold suspension in 1971 • Large devaluations persisted and repeated many times for some countries even as they left gold parities • One would have expected trade to fall faster in the Great Depression than in the Great Recession 8

Number of devaluations greater than 10 percent 1923-1938 Year Number 1923

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1924 1925 1926 1927 1928 1929 1930 1931 1932

6 2 4 0 0 1 1 3 9

1933 1934 1935 1936 1937 1938

6 6 1 3 5 2

Countries Austria, Belgium, Denmark, France, Germany, Greece, Hungary, Poland, Romania, Yugoslavia Belgium, Bulgaria, France , Germany, Hungary, Japan, Norway Greece, Hungary Belgium, France, Greece, Poland Spain Spain Austria, Italy, Spain Austria, Denmark, Finland, Greece, Japan, Norway, Spain, Sweden, United Kingdom Canada, Denmark, Greece, Japan, United States, Yugoslavia Canada, Czechoslovakia, Denmark, Japan, Norway, Sweden Belgium Italy, Romania, Spain Czechoslovakia, France, Italy, Spain, Switzerland France, Netherlands

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Decline in World Output and World Trade The Great Depression and The Great Recession

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The Great Recession Summary of Varying Views • Housing bubble in the US generally accepted as precipitating 2008 global financial crisis – combination low interest policy, sub-prime mortgages, novel financial instruments, etc. • A larger (competing) perspective – Emerging Market Economies (EME) had hand in bubble making; EME central banks recycling surpluses a significant part of market for US treasuries and securities; EME participation lowered real longterm interest rates; EME engaged in preventing currency appreciation generating surpluses 11

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Source: Collignon 2011

Shadows of Currency Wars • Despite new research and greater exchange rate flexibilities (marked exception: China), events of Great Depression and instruments continue to be appealing in current conflicts • Combined US and EU crisis and lukewarm impacts from measures point to analogous environment of the 1930s • And the combatants to this currency war are defined – EME and the US; deficit and surplus economies; reserve-source and reserve-using economies • More specific war corridors – China and US 14

• At the heart of the conflict is the manner in which US deficit and China surplus is to be reduced and the role of exchange rate in the process • On one side is tight capital control and peg in China – perceived as hindering adjustment, loss of competitiveness )deploy tariff equivalent to undervaluation • On other side is too loose US monetary policy – perceived as ineffective as China surplus is not cause of US deficit )impose retaliatory tariff or accumulate reserves 15

• Collapse of gold and dollar regimes driven by overriding domestic objectives that clashed with currency objectives • History lesson is that location for adjustment may not be in trade area or in exchange rates • Attention to domestic reforms on both deficit and surplus areas can put war footing at bay • Both sides clearly experiencing disturbances beyond exchange rates )output well below trend, unemployment record highs, debt soaring – in deficit areas )overheating, distortions - in surplus areas 16

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Weapons of War and Subtle Impacts • Weapons of mass unemployment and competitiveness have seldom been effective – in the gold or dollar regimes assuming they were the prime motivations • In the 2008 crisis trade barriers were hardly erected • But disappointing results from initial policy guns in deficit areas, more direct and aggressive weapons have been used 19

• QE aims more directly at trade as stimulus via money printing spills over to the rest of world • 2 rounds of QE prompted label of currency war • EME have used defensive weapons of capital controls and restrictions and variety of arsenals • With another round of QE, it is not clear how the EME (particularly China) would respond • Nor is it clear that there would be a victor and a vanquished • More real threat is the international monetary system itself 20

• There may be other weapons with subtler effects • Allowing appreciation, real productivity increases would lead to lower unit prices of tradables • Product innovations can similarly reverse real appreciation • Technological changes can shift out total productivity • Armory of policies to raise investments and alter consumption to domestic sources mute appreciation • These weapons work equally for depreciation 21

• These weapons do not fire directly into the contemporary fray but address the real roots of asymmetry and lack of balance • To use these require examination of domestic environments and formulation of reforms • Reduce demand from deficit areas and increase demand from surplus areas • They require attention beyond exchange rates • But their movement form part of the steps to cessation of hostilities and search for right solution 22

Collateral Damage and Direction • What might be the collateral damage to other trading nations than those at the center of a currency war? • Can not be easily answered, need further study, and a sequel to this • Consider effects of (a) RMB revaluation, (b) China reforms for rebalancing, and (c) deficit area reforms 23

• Important factors to take into account – similarity or dissimilarity of country to China’s pattern of trade; net bilateral relations with China; impact of China’s growth (e.g. slowdown) on country • Investigate an argument that China’s currency undervaluation undercuts competitiveness of poor region industries, slow down their growth, and lead them to distorted growth paths • Important to measure effects of contemporary conflict in terms of own-country damage and paths to follow 24

Thank you…

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