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News : Global Economy Last Updated: Oct 7, 2010 - 9:16:34 AM


IMF's Strauss-Kahn warns governments on their currency's exchange rate as a weapon to boost demand
By Michael Hennigan, Founder and Editor of Finfacts
Oct 6, 2010 - 6:40:30 AM

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IMF managing director Dominique Strauss-Kahn has warned governments about using their currency's exchange rate as a weapon to boost demand.

In recent times, Japan has intervened to push down the value of the yen; China unpegged the renminbi from the US dollar last June but its rise in value since has been about 2% which hasn't pleased the US which argues that the Chinese currency maybe undervalued by as much as 40% against the dollar;  on Monday, Brazil hiked a tax on foreign capital used to buy bonds and other fixed-income investments. Last week Brazilian finance minister Guido Mantega accused leading economies of deliberately devaluing their currencies -- and thus making the real more expensive. This had sparked "an international currency war," he said 

After the 1997 Asian crisis, most countries in the region switched to a deliberate FX reserve accumulation policy on the back of surging trade surpluses and, in many cases, surging capital inflows, frequently supported by undervalued exchange rates. Similarly, large current account surpluses in oil-exporting countries due to rising energy prices led to rapid official foreign asset accumulation during the 2000s. In the Middle East, this not infrequently took the form of non-reserve assets controlled by the official sector rather than reserve accumulation. Unwilling to revalue their currencies, several large emerging economies soon ended up holding “excess” FX reserves, leading them to set up sovereign wealth funds with the explicit mandate to invest “excess” reserves in higher-yielding assets.

China's FX holdings rose by $7.2bn to $2.454trn at the end of June 2010 from the end of March.

Some $900bn are in US Treasuries and between 65 and 75% reserves are in US dollars.

"There is clearly the idea beginning to circulate that currencies can be used as a policy weapon," the IMF's Strauss-Kahn told the Financial Times.

"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," he warned.

Strauss-Kahn's comments came ahead of annual meetings of the IMF and World Bank in Washington at the weekend.

Each G20 country agreed to submit its own plan for restoring economic growth and many countries are relying on external demand as the engine of growth.

Earlier in the week, Charles Dallara, Managing Director of the Institute for International Finance, which represents 420 global banks, called for urgent action by a core group of the world’s major economies to broker agreements on critical macroeconomic and exchange rate issues. He said, “Sustaining growth and restoring confidence will require not only astute domestic policymaking, but an unprecedented level of multilateral coordination. It will also require action that transcends purely domestic short-term concerns.”

Dallara stated in a letter on behalf of the IIF’s board of directors to the finance ministers and central bank governors who will be meeting in Washington DC in the forum of the IMF’s International Monetary and Finance Committee: “The challenge for global leaders is to recapture the political commitment to decisive, coordinated action that made the London Group of 20 Summit (April 2009) successful in restoring confidence battered by the crisis—and to use that commitment to take immediate and concerted policy measures within a multilateral framework. Market participants need to be convinced that the leaders of these major economies recognize their individual and collective responsibilities to work towards the goal of balanced and sustainable global growth.”

Global Currency War: Central banks around the world are on the move this morning with questions about who will ease and who will hold rates, with CNBC's Steve Liesman, and Steven Ricchiuto, Mizuho Securities USA Inc:

Fred Bergsten, who is director of the Peterson Institute for International Economics think-tank and a former US Treasury official said in an article in the Financial Times on Monday that the competitive undervaluation of China is infecting the entire global economy.

He proposed the introduction of a new policy instrument: countervailing currency intervention. When China or Japan buy dollars to keep their currency substantially undervalued, the United States should sell an equivalent amount of dollars to push back. The IMF should authorize such intervention when necessary to discipline countries that are violating their obligations by engaging in deliberate undervaluation.

Wen Jiabao, the Chinese premier, this week said China may buy Greek bonds. Such a move would push up the euro.

The Chinese are reluctant to follow the path of Japan in 1985 when an agreement was reached at the Plaza Hotel in New York to raise the value of the yen.

US economics professor, Khairy Tourk, said in a letter in the FT this week that according to the Bank of Japan, after the Plaza Accord, the private sector raised ¥405,000bn ($4,850bn) between 1985 and 1990; 74% of the funds went into stocks and land, and only 36%cent was invested in the industrial sector.

Tourk says China’s present level of technological development is no match to Japan’s technological prowess around the time of the Plaza Accord and it therefore cannot offset the higher currency value by moving production to cheaper locations in Asia  -- there are simply very few.

Martin Wolf in the FT today says: "A trade war would be very dangerous. Insisting that China stop purchasing the liabilities of other countries so long as it operates tight controls on capital inflows is, instead, direct and proportionate and, above all, moves the world towards market opening."

SEE:

1)The effect of a renminbi appreciation on US-China trade imbalances

2) From currency war to lasting peace

3) How to level the capital playing field in the game with China

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