The Currency War

Everyone is talking now of the “currency war” that seems to be breaking out among the world’s leading economies, each working for a depreciation of its currency vis-à-vis the others.  The effect of a currency depreciation is to enlarge the exports of the country undertaking such a depreciation and to reduce its imports, since its goods become cheaper compared to those of other countries.  In short, currency depreciation increases a country’s net exports, ie, its market at the expense of other countries.  It enlarges the country’s output and employment, but at the expense of other countries, which is why increasing domestic employment through a currency depreciation is often referred to as an instance of a “beggar-my-neighbour” policy.

If world aggregate demand was increasing then there would be little cause for competitive currency depreciations, since domestic employment in each country would be increasing even in the absence of such depreciation.  The reason for countries being engaged in such competitive depreciations, ie, in snatching each other’s markets, lies precisely in the fact that world aggregate demand is not increasing, ie, that the world crisis is persisting.  Till now the same people who are now so concerned about the currency war were declaring confidently that the world crisis was over, which just shows the superficiality of their understanding.  In fact the crisis is going to be prolonged and acute.  This explains the currency war, the desperation of each country to improve its position at the expense of its neighbour, since there is no other silver lining on the horizon.

But the currency war itself will deepen the crisis.  If there is uncertainty about what the configuration of exchange rates will be some months from now, and hence about what the size of the market of any particular country will be some months from now, then this acts as a disincentive for private investment everywhere, which only compounds the recession.  In addition, if uncertainty about relative currency values makes wealth-holders shift to gold or oil-futures, or other commodity-futures, as their preferred form of holding wealth, then this gives rise to inflation; and the typical means of combating inflation in contemporary capitalist economies, which is the pursuit of contractionary monetary and fiscal policies, only worsens the recessionary crisis.  In short, the currency war is both a reflection of the abiding nature of the current crisis and a means of its accentuation.

Most Western, especially American, commentators lay the blame for the currency war at the door of so-called “newly-emerging” economies, especially China and other Asian countries (which includes India).  Their argument runs as follows: there are serious imbalances in the world economy arising from the fact that the US is running a massive current deficit, while China above all, and some other newly-emerging economies, are running current account surpluses.  This basic imbalance also causes speculative flights of finance capital from the crisis-hit USA to China and the newly-emerging economies.  If the currencies of the latter were allowed to appreciate, then those of the USA (and other advanced countries) could remain more or less stable vis-à-vis one another and vis-à-vis any other medium such as gold or commodities.  But China and other newly-emerging economies have prevented such an appreciation and have instead soaked up whatever dollars flow into their economies in the form of higher foreign exchange reserves.  It is this which puts pressure on the value of the dollar.  Chinese undervaluation of the currency therefore is the “original sin” that starts the currency war.  So the US House of Representatives allowed the government to impose countervailing duties on imports from China, on the grounds that such imports derived an “unfair” implicit subsidy owing to China’s undervalued currency.

This entire perception however misses the point.  Suppose China allows its currency to appreciate.  That would basically mean that Chinese goods would no longer be as cheap as they were earlier.  While this fact would certainly mean a reduction in China’s net exports, and, hence, immediately at any rate (since no other country can step into Chinese shoes at short notice), an improvement in the state of current account imbalances in the world economy, it would, other things remaining the same, cause a reduction in China’s employment and output as well.

The only way that China can avoid such a reduction in output and employment, while appreciating its currency, is if it simultaneously increased its government expenditure or government transfers to the people to raise their consumption.  If it did so, then the reduction in net exports on account of the appreciation of its currency would have been offset by the increase in government expenditure, so that its total level of aggregate demand, and hence its output and employment, would have remained unchanged.  But if China did so, ie, shifted from net exports to government expenditure (which includes transfers to the workers and peasants) as a source of aggregate demand, then there would be no need for it to appreciate its currency at all.  The improvement in global imbalances and the stimulus to global aggregate demand that a Chinese policy of “currency appreciation plus enlarged government expenditure” would bring about could be equally well brought about by enlarged government expenditure alone.

What is equally striking is that the very same commentators, the very same US Congressmen, the very same spokesmen for finance, who vociferously condemn China’s undervalued exchange rate, are also the ones who, day in and day out, oppose with vehemence any increase in government expenditure anywhere and who are all for rolling back even President Obama’s minuscule stimulus package.

Those who advocate an appreciation in China’s (and other emerging economies’) currency cannot possibly hold that an increase in government expenditure for removing unemployment is bad everywhere else, but not in China.  They cannot possibly hold that an increase in, say, workers’ wages as a means of enlarging domestic demand for eliminating unemployment (such as would arise if the currency gets appreciated) is good for China, while in the US a situation of unemployment must be met through a cut in workers’ wages.  In other words, they cannot possibly advocate the use of precisely those weapons, which are the only weapons available, for overcoming unemployment in China, when they are opposed to their use in the US.  It follows that those who are advocating an appreciation of the Chinese currency must believe either that such appreciation would cause no unemployment in China, which is patently wrong, or that unemployment in China does not matter, which is patently chauvinistic.  Which one is it?  As a matter of fact it is a patently chauvinistic argument being put forward via a theory that is patently wrong.  Let us see how.

The fundamentally wrong theory that finance capital puts forward, via numerous economists and commentators who echo its views and are adulated professionally for doing so, is that the free and unfettered operations of markets in a capitalist economy automatically brings about a state of “full employment” (which means not that everybody is employed but that the only unemployment which remains is either voluntary or frictional or because the search for jobs, which are in any case lying around unfilled, takes time).  Even in the midst of the greatest crisis since the 1930s Depression, this position has not been abandoned.  It received a jolt at the start of the crisis but it has once more regained its hegemony, thanks to the assiduousness of the propaganda by financial interests.  How else does one explain the fact that, even in the midst of almost 10 per cent unemployment rate in the US, there are strong demands for Obama’s stimulus package, which was extremely paltry to start with, to be withdrawn?  The belief obviously is that, even without such stimulus, the economy would automatically move to full employment, provided wages are sufficiently flexible (ie, are sufficiently cut), a view which was held by Herbert Hoover, US president before Franklin Roosevelt, and which was resoundingly disproved by the collapse of Hoover’s policy that accentuated the Great Depression.

Now, on the basis of this theory, where aggregate demand does not matter, where Say’s Law, that supply creates its own demand, holds, a currency appreciation by China and other emerging Asian economies cannot possibly cause unemployment in those economies; it can only have the salutary effect of removing world imbalances.  When US Treasury Secretary Tim Geithner says that countries like China, by interfering in the determination of their exchange rates, are not allowing free markets to function as they should, he is implicitly suggesting that if China allowed the foreign exchange market to function, it would be good for all including China, ie, that an appreciation of the Chinese currency, which a “free” foreign exchange market will bring about, is not a cause for worry from the point of view of employment and output in China.  He is in short, like all spokesmen of finance, downplaying the unemployment-generating effect of a currency appreciation.

It may be argued that this is an unfair inference to draw, that those who are asking for an appreciation of the Chinese currency (and of other Asian currencies) really have in mind something altogether different.  They recognise that such appreciation will cause unemployment in China, but would like the Chinese State to step into the breach by increasing its expenditure, in which case it would have begun to play the role of a locomotive for the world economy as a whole, ie, taken over in part a role which the US has been playing single-handedly, but which it can no longer afford to do.  But if this is the argument, namely that China should absorb more goods domestically and thereby boost world demand, then there is no reason why, for doing so, it should appreciate its exchange rate at all.  In other words, the argument that China should henceforth play a leading role in stimulating world demand is quite independent of the argument about the need for China to appreciate its exchange rate.

The fact that it is exclusively the latter argument that is advanced by spokesmen of finance and all right-wing forces suggests something quite different, namely that, within the existing world market, China and other Asian countries should yield a larger share to the US and other advanced capitalist economies, ie, the solution to the capitalist crisis in these latter economies should come about through unemployment and recession in China and other Asian economies, much the way that perpetrating “de-industrialisation” on the colonies was the means of achieving prosperity in the metropolis in the old days.  This strategy is sought to be camouflaged by the absurd theory that such unemployment will automatically disappear, through the spontaneous functioning of markets; but it is nothing else but a “beggar-my-neighbour” policy being sought to be imposed by the advanced capitalist countries on the newly-emerging economies.

The need for this arises because at the moment there are no prospects of an expansion in the level of world aggregate demand.  The leading capitalist country, the US, is not in a position to provide a lead in this regard because any expansion on its part will increase its current account deficit in the prevailing situation (ie, in the absence of recourse to protectionism on its part); countries like China are still not large enough to lead the world in the matter of boosting aggregate demand; and a coordinated expansion of world demand by several countries simultaneously providing a fiscal stimulus is totally unacceptable to international finance capital which is always opposed to any State activism of this sort.  With the total size of the world demand thus constrained, “beggar-my-neighbour” policies and currency wars are the only means left for countries to climb out of the recession.  Recourse to such policies is bound to intensify.  They are a symptom of the impasse in which capitalism is currently caught; and they also accentuate it.

Prabhat Patnaik is a Marxist economist in India.  This article was first published in People’s Democracy on 17 October 2010; it is reproduced here for non-profit educational purposes.

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