Currency War or Peace for Our Time?

Irwin M. Stelzer is a contributing editor to The Weekly Standard, director of -economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).

Manufacturing activity is up, according to some reports but not according to others; demand for financial services is somewhere between stable and modestly up; and consumers are spending a bit more but only on well-priced necessities. Construction is falling in response to weakness in the housing commercial property markets. Only farmers seem to be reaping what they sowed -- worldwide demand is generally good, crop yields are high, and prices for commodities such as corn are moving up.

Put it all together and it spells gloom. Citigroup reports that 86 percent of small business owners fear a double-dip recession, and it is this group that everyone counts on to create the jobs needed to bring down the dole queues. Little wonder that Fed chairman Ben Bernanke is about to launch a new stimulus, generally known as QE2, in the hope of getting the economy moving and of avoiding deflation. The fear of a decade of falling prices, such as what Japan experienced, looms large in the Fed's thinking. Its report notes that "prices of final goods and services were stable" last month, which once would have been good news for a central banker, but now is considered far less desirable than a 2 percent inflation rate.

But this new vessel, the QE2, might be designed somewhat differently than the first quantitative easing, the now-standard euphemism for printing money. Word out of Washington -- disagreement at the policy level in the Fed makes leaks the communication method of choice these days -- is that instead of a massive purchase of government bonds, the Fed will dribble out dollars, perhaps $80-$100 billion each month for six months, and calibrate the next month's output of greenbacks to the economy's reaction to each infusion. That, instead of a "shock and awe" $1 trillion over a set period. The gradualist approach would reflect the fact, as the Lindsey Group puts it in a recent report, that "Central bankers … have a high degree of uncertainty about what the actual outcome of QE is going to be…" Some economists who believe that printing money is not a sure path to economic growth are pointing out that by keeping interest rates low and capital cheap, the Fed is encouraging capital-intensive investment rather than job-creating labor-intensive ventures.

There is only one thing that economists feel they can say with certainty about the consequences of another round of quantitative easing: it will produce selling of the dollar. Which takes us all the way from the Fed's boardroom to Seoul, Korea, and next month's gathering of the G20.

America's trading partners are decidedly unhappy with the prospects of another batch of dollars rolling off the printing presses. Economic recovery in Europe depends in important part on the ability of Germany's export machine to be the locomotive that pulls the EU out of the slow growth it is experiencing. Indeed, with Britain having joined the austerity-now group of nations -- Ireland, Portugal, Spain, Greece, with riot-torn France trying to join the group -- German exports are increasingly key to whatever growth the EU can muster. And a falling dollar, aka a soaring euro, is of no help on that score. Indeed, German exports have already started to decline in response to the weaker dollar, down 17 percent against the euro since early June, and European luxury-goods manufacturers are reporting "headwinds" resulting from the stronger euro.

The European finance ministers now meeting in Gyeongju, Korea, to pave the way for a meeting of their bosses on November 11, are in a grumpy mood. The Brazilians are very unhappy about the inflow of hot money seeking returns higher than are available from low-yielding U.S. Treasuries. So they have announced a 6 percent tax on foreign purchases of their bonds to stem the capital inflow. And for whatever reason the Brazilian finance minister and central bank chief have decided not to attend the finance ministers' meeting that started today.

To add to the unilateral actions that are making it increasingly unlikely that any meaningful agreements will come out of Seoul, even the hosts -- with their international prestige likely to suffer if the meeting ends in disagreement -- have indicated they will curb capital inflows by holding down the won, which has already risen by 40 percent against the dollar, and taxing foreign investors' earnings on South Korean bonds. China, too, is decidedly unhappy about a dollar-printing policy that will reduce the value of the pile of dollars stored in the vaults of its central bank. And at the pressure it is facing to allow the value of its yuan to rise.

All of which has Bank of England governor Mervyn King worried that we will see a wave of protectionism "that could, as it did in the 1930s, lead to a disastrous collapse in activity around the world," and Indian prime minister Manmohan Singh pleading for an end to the currency wars that have erupted since Bernanke began his public musing about the need for QE2. Singh wants to see a peaceful rebalancing of world trade, with trade-surplus nations such as China and Germany relying more on domestic consumption and less on exports, and America and other deficit nations doing the opposite. But that will require major changes in the economic policies of China, Germany (Rainer Brüderle, Germany's economic minister denies France's charge that it is relying almost exclusively on exports), the U.S. and other countries.

Not likely. This is political season in America, and it won't end with the congressional elections in nine days' time. On the tenth day the politicians will not rest, but begin the 2012 presidential race. That means China-bashing by congressional and presidential candidates, especially Democrats desperate for trade union cash and grassroots foot soldiers. On the other side of the battle line, China, about to anoint a new leadership group, will keep exports up to provide jobs for an increasingly restive population. And if that means a continued currency war, so be it. In short: don't count on peace for our time.

By Irwin M. Stelzer:
Reprinted with permission from The Weekly Standard