The United States will go on the defense at this week's Group of 20 (G20) meeting, having to explain its quantitative easing (QE2) policy to foreign leaders who have criticized the move as a currency war tactic to weaken the dollar and damage other countries' export-driven recoveries.
China, Brazil, Germany and South Africa all have spoken out against the U.S. Federal Reserve's announcement last week that it will buy $600 billion in U.S. Treasuries through June. Finance policymakers from around the globe say the move will depress the dollar and drive capital flows to emerging markets, creating asset bubbles.
Brazil's central bank president Henrique Meirelles said the extra liquidity in the U.S. economy would cause "risks for everyone," and German Finance Minister Wolfgang Schaeuble called the Fed's move "clueless."
"It doesn't add up when the Americans accuse the Chinese of currency manipulation and then, with the help of their central bank's printing presses, artificially lower the value of the dollar," Schaeuble in an interview with Der Spiegel magazine published this weekend.
At an Asia-Pacific Economic Cooperation (APEC) meeting of finance ministers this weekend, representatives from the Philippines and Thailand said the Fed's policy was pushing unwanted capital into their countries and damaging economic stability.
However, analysts said foreign leaders are mistaking the decision as a currency war action, and should be relieved the United States is making moves to spur growth that could strengthen the global economy.
"A lot of this criticism is misplaced since the Fed is not deliberately attempting to weaken the dollar; this is simply a side-effect of a monetary policy that is being shaped by domestic considerations," wrote Julian Jessop, an analyst at Capital Economics, in a note. "What's more, policy-makers in many emerging economies would presumably rather deal with the problems of stronger currencies and capital inflows than the fall-out from a renewed US economic downturn and a collapse in global commodity prices if the Fed wasn't doing enough to support the recovery at home."
U.S. President Barack Obama defended the move in a press conference yesterday (Monday) ahead of this week's G20 meeting, saying the stimulus measure will boost U.S. economic growth and would be "good for the world as a whole."
Brazilian officials have hinted they will retaliate against the Fed's actions, which they see as a move to weaken the dollar and continue the global currency war. Brazil's real has climbed 39% since the beginning of 2009 and industrial output fell by 2% from March to September. Officials are concerned the export and manufacturing numbers will only get worse with the Fed's policy.
"It's no use throwing dollars out of a helicopter," Brazilian Finance Minister Guido Mantega said last week. "The only result is to devalue the dollar to achieve greater competitiveness on international markets."
Brazil has been flooded with capital as the country's benchmark interest rate is at 10.75%, the highest of the G20 member nations. Brazil imposed a 6% tax on bond inflows, but it has done little to curb the trend.
Last week Brazil's outgoing president Luiz Inacio Lula da Silva said he would be traveling to the G20 meeting in Seoul, South Korea with president-elect Dilma Rousseff, ready to take "all the necessary measures to not allow our currency to become overvalued. They'll have to face two of us this time."
The biggest target of currency war criticism has been China, as more countries speak out against its lack of flexibility in yuan appreciation. But some think China may have already cooperated with the United States in a currency deal, although neither country has admitted to doing so.
Douglas Borthwick, head trader of Faros Trading, said last month that the two nations may have agreed to let the yuan appreciate over five years, with an average annual rate of 7.8% resulting in a 40% value gain overall. Borthwick said the five-year span gives the United States time to grow exports while China builds domestic demand.
Borthwick also said the Fed's QE2 measure is a form of "gentle prodding" to push for faster currency appreciation, as China is often flooded with capital when the policy is employed.
Analysts have said failure to calm currency tensions at the G20 summit would bring countries a step closer to a global trade war.
U.S. Treasury Secretary Timothy Geithner is expected to stand his ground in requesting countries with huge trade surpluses cut them to just 4% of gross domestic product (GDP). China and Germany top the list of high-trade surplus countries, both with around 5% of GDP.
Germany has been defending its export-driven economic model as foreign leaders claim its trade surplus is hurting the recovery of the United States and other weaker Eurozone nations. Now Germany is taking the opportunity to hit back at U.S. policies.
"The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base," said Schaeuble. "There are many reasons for America's problems – German export surpluses aren't one of them."
With leaders as frustrated and defensive as they are, analysts think it's unlikely much will be changed from this week's meeting.
"[T]he most likely outcome is an inconclusive G20 Summit that takes the world a step closer to a global trade war," wrote Capitol Economics' Jessop. "The U.S. trade deficit with China has continued to widen and is the obvious flash point, but other countries may also decide to adopt protectionist measures to boost their economies once monetary and fiscal options are exhausted. Needless to say, this could increase volatility and curb the renewed enthusiasm for risk in financial markets."
Jessop said the chance of China's cooperation in trade matters is slim. China's trade surplus could rebound again as the global economy recovers, and reducing it a percentage point would be difficult to maintain.
"It seems unlikely that China would be willing to appear to bow to international – and specifically US – pressure to tie its hands with a current account target at the expense of other policy objectives," wrote Jessop. "And even if China did sign up to a current account target, would this commitment really be worth anything? There has been little evidence that China is able or willing to take the necessary steps to boost domestic demand."
News and Related Story Links:
- Money Morning:
Fed's "QE2" Could Fuel Inflation in U.S. & Deflation in Europe
Trichet Says Fed Move Wasn't Aimed at Weaker Dollar
- The Wall Street Journal:
Germany Criticizes Fed Move
- Financial Times:
Obama defends QE2 ahead of G20
- International Business Times:
World could be closer to trade wars post-G20
- Financial Times:
Brazil ready to retaliate for US move in 'currency war'
- International Business Times:
Did U.S. and China strike a currency deal?
- Money Morning:
Currency War: China Stands Firm on Yuan as Global Criticism Escalates