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october 16, 2010

Conflict over Exchange Rates
The conflict between the US and China over the renminbi-dollar exchange rate is set to deepen.
he grim portraits of the world economy, and especially those of the United States (US), the euro-zone countries and Japan, sketched by the International Monetary Fund’s (IMF) October 2010 World Economic Outlook and Global Financial Stability Report set the tone for last weekend’s semi-annual meeting of the Bretton Woods twins. Brazil’s finance minister, Guido Mantega’s public assertion in Sao Paulo towards the end of last month of the existence of a “currency war” had already disturbed the mood. But, as expected, the final communiqué only produced a set of platitudes, nothing more. Rhetoric though was much on display. On the eve of the meeting, the IMF’s managing director, Dominique Strauss-Kahn, warned that the historical record proved that use of currencies as a competitive weapon could lead to a “catastrophe”. US Treasury Secretary Timothy Geithner found fault with China’s “significantly undervalued” currency, without, of course, naming the dragon country, and went on to ask the IMF to strengthen its “surveillance of exchange-rate policies and reserve accumulation practices”. The governor of China’s central bank, Zhou Xiachuan, in turn, blamed the unconventional monetary policies of the “major reserve currency issuers” (read mainly the US Federal Reserve) and the failure of the developed countries to repair and reform their financial systems. He even talked about the possible deterioration of sovereign risks leading to global financial instability (Was he implying that a sovereign debt crisis might unfold in the US?)! The spokesperson of the euro-zone finance ministers, JeanClaude Juncker of Luxembourg, felt that the G-20 was not capable of finding a solution to the currency conundrum and that the G-7 plus China was the ideal forum for a resolution. That puts a question mark on whether the 11-12 November G-20 meeting in Seoul would produce anything other than pious banalities. The floor was left to the candid Guido Mantega to suggest a practical solution – he came up with the idea of the G-20 working out “something like a Plaza Accord”. Now, the Plaza Accord of 22 September 1985 was an agreement between France, Japan, the then Federal Republic of Germany, the United Kingdom and the US to significantly depreciate the dollar vis-à-vis the Japanese yen and the German deutsche mark by a coordinated intervention in the currency markets. “Something like a Plaza Accord” would presumably imply a coordinated intervention in the forex markets to significantly depreciate the dollar
Economic & Political Weekly EPW

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vis-à-vis the euro, the yen and the renminbi (RMB). However, unlike the other currencies, the RMB is presently on a managed float within a very narrow band. More significant, though, is the fact that in 1985, the US still exercised economic hegemony vis-à-vis the other major powers. Today this is not the case, what with the US economy in decline and the rapid rise of China. Yet, global capitalism needs a stable reserve currency, and though the US dollar is faltering in its ability to play that role, none of the other possible contenders (the euro, the yen and the RMB) are anywhere near taking its place. Let us leave aside the politics of the matter and come to the macroeconomics of the major trade imbalances and the consequent capital flows. Looked at from the current accounts of the balance of payments, the most simple explanation is that “overspending” in the US is the main cause of its huge trade deficits, apart from the exchange rate policies of the trade surplus countries. But are higher savings in the US and appreciation of the currencies of the trade surplus countries the answers? In other words, would belt tightening in the US and a reduction of its trade deficit through export expansion and import compression, solutions proposed by the mainstream, resolve the problem? Frankly, these “solutions” would push the world economy into a deep recession. Ben Bernanke, the chairman of the US Federal Reserve , in his “savings glut” hypothesis which he has been articulating since 2005, has looked at the problem from the side of the capital accounts of the balance of payments. In his view, the US “overspending” which causes the trade deficit is, in turn, caused by the capital inflows from the current-account-surplus countries. These huge capital inflows spur credit expansion and lower long-term interest rates, which induce higher household consumption. The problem then is the “savings glut” in the trade surplus countries and the solution (not Bernanke’s) is a Keynesian one – increase domestic aggregate demand in these countries. There is another dimension to global capital flows – their return overseas. The huge “quantitative easing” (central bank buying of government securities) by the Fed, which in the presence of very low interest rates, is leading to a massive speculative outflow of dollars from the US in search of high-yield assets in the emerging markets, including China. This has led to a further tendency of the domestic currencies to appreciate, impelling the central banks to buy dollars in the forex markets to safeguard the

october 16, 2010

vol xlv no 42

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The search committee set up by the state government in 2009 to select the final five candidates for the post was dissolved even as a public interest litigation on the selection process was pending in the Bombay High Court (HC). While the chief minister has made the correct conciliatory noises. has a stake in the undervaluation of the RMB vis-à-vis the dollar. The Parsi protagonist’s personal “long journey” plays out against socio-political events in the Bombay of those times and the Nagarwala bank scandal. The college principal’s statement. it is the education minister’s stand that is indicative of how the Shiv Sena finds the gumption to make such outrageous demands and have them met. but that Welukar’s qualifications do not befit the VC’s post. Rajan Welukar. took over in July. The point is this: Looking at these inflows and outflows of dollars via the US financial system. Its long history of issuing threats and unleashing physical violence against poor migrants. the recipient of many prestigious awards and with an enviable literary reputation. what is disregarded by analysts is the fact that more than 50% of China’s exports are the result of the business activity of the Chinese affiliates of transnational corporations and/or the subcontracting of manufacturing by large US or European retailers/marketers. T The Mumbai University meanwhile has been dogged by controversy over the appointment of a vice-chancellor (VC) for well over a year and for its deteriorating academic and infrastructure facilities for longer. Mistry is an alumnus of the St Xavier’s College where Aditya Thackeray is presently studying. the surplus countries’ reserves. the city’s dabbawallas and the party itself in a book published 20 years ago and that has been part of the syllabus for four years. is set to launch his Yuva Sena shortly. it is unlikely that the G-20 will be able to find a way out at Seoul next month. So too the fact that in almost all cases the state government’s reaction has helped to project it as a party that must not be displeased. The Mumbai University’s craven response to the party’s demand to withdraw Rohinton Mistry’s Such a Long Journey from the second year BA syllabus and the state government’s lame reaction are in keeping with the past practices of the Shiv Sena and the weak-kneed response of the government of the day. the conflict between China and the US over the RMB-dollar exchange rate. 2010 vol xlv no 42 EPW Economic & Political Weekly 8 . a significant section of US industrial capital. the Shiv Sena’s student wing. 1994 and the norms of the University Grants Commission flouted. is set against the backdrop of the 1971 Indo-Pak war. 1994 to remove the book within 24 hours of the demand showed how keen the university was to bow before the Shiv Sena. Is it not unreasonable that literature is banned merely because it dares to critique us?” october 16. son of another Shiv Sena breakaway and current Congress minister. Narayan Rane. against those whom it tars as “anti-Indian” and against all those who do not conform to the Marathi asmita (identity) is also known. The new VC’s use of the emergency clause of the Maharashtra Universities Act. Given the complexity of the issue – the renminbi-dollar exchange rate – and the relative power of capital on both sides of the Pacific.EditoRials price competitiveness of their country’s exports and sell government securities to sterilise the effect of the purchase of dollars on the money supply. son of Shiv Sena executive president Uddhav Thackeray and grandson of founder Bal Thackeray. of course. The Bharatiya Vidyarthi Sena. and keeping in mind that finance is fungible. whilst he himself was a member of the search committee. “invested” in the US. “It is inconceivable that in the 21st century. Moreover. The minister said that he has asked the VC to inquire as to how the book found its way into the syllabus in the first place! Ironically. leading to another round of the cycle. The new search committee was criticised by senior academics because it was the education secretary to the Government of Maharashtra and not an academic who drafted the eligibility rules for members of the search committee and the candidates for the VC’s post. is well-known. such a sharp decline By caving into the Shiv Sena’s outrageous demand. The epicentre of this whole conundrum of trade imbalances and capital flows is. In this. including the Marathi manoos it claims to champion. Mumbai University continues its long decline. Hence. a political party will not show the maturity to accept criticism and answer it by the evidence of its own actions. Aditya Thackeray’s launch into politics is seen as an answer to his uncle Raj Thackeray. The context is that the Mumbai University’s senate elections are round the corner and the 20-year old Aditya Thackeray. A former pro-vice-chancellor of the university has appealed in the court against Welukar’s appointment claiming that not only were the provisions of the Maharashtra Universities Act. which makes huge profits from its Chinese operations and/or its outsourcing/sub-contracting. it is in the interests of those who keep their wealth mainly in dollar-denominated assets – those at the apex of the global wealth pyramid – to maintain a strong dollar. All this has vitiated the atmosphere within the university and further sullied its academic image. the university functioned with an acting head. are recycled by the US financial system to the emerging markets in search of higher returns. and part of the dollars that return constitutes an accretion to the forex reserves. He is also expected to counter the aggressive posturing of Nitesh Rane. who broke away to form his own party and in the process took away a large chunk of the Shiv Sena’s young supporters. The entire episode holds up a mirror to the gradual deterioration in the academic standards of the 153-year old Mumbai University. Mistry’s book. For almost a year before the present VC. he Shiv Sena’s propensity to violently agitate over issues totally unconnected with the immediate problems confronting the residents of Mumbai. has just woken up to the allegedly offensive remarks against the Marathi manoos.