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The New Currency War

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).

They came. They met. They dined. They whined. And then the finance ministers, gathered for the meetings of the International Monetary Fund and the World Bank, representing some of the most indebted countries in the world, flew out of Washington, filling the first class sections of most of the international flights leaving Dulles airport.

There was some sound, a bit of fury, and nothing of significance done about the huge trade imbalances threatening long-run global prosperity. Add policy paralysis to the decision by the Federal Reserve Board to print more dollars, and the result is a rapid and significant collapse of the dollar, accelerated by two bits of news. America's trade deficit with China hit a record last month, and China refuses to abandon its policy of keeping the value of its yuan pegged to the dollar, with the usual exception of allowing a slight upward movement in order to appease its critics in advance of an important international gathering.

So it's on to Korea, and a meeting of finance ministers on October 22-23 in Gyeongju to prepare for the big talkfest when their bosses meet in Seoul on November 11-12. The prospects for coordinated international action are dim indeed. The key that might unlock the policy paralysis is in President Obama's pocket. But he is reluctant to use it. For two reasons.

First, basic to all administration policies is the belief that American power and influence must be submerged in a variety of international bodies lest that power be used for ill as, allegedly, it was in Vietnam and Iraq, not to mention throughout most of history -- hence Obama's serial apologies for American conduct. So when world leaders look for America to take the lead in imposing an economic pax Americana on a troubled world, something they wish for despite publicly denied such aberrant thoughts, they are apt to be disappointed.

Second, the presidential election campaign begins on November 3, the day after the current round of congressional elections, and the president will need some red meat with which to keep his protectionist-minded trade union supporters well fed. That inclines him towards the combination of a cheap dollar and import restrictions that his international couterparts fear will bring on trade and currency wars, with disastrous consequences for the world economy.

The mood pre-Korea is rancorous. The Japanese are accusing the Koreans of artificially depressing the won in order to seize export markets from Japan; the Brazilians and Thais, among others, are blaming the easy-money policy of the Fed for an inflow of hot money; EU officials call the U.S. "irresponsible;" the Americans and Europeans are blaming the Chinese for artificially depressing the yuan; the Chinese, adding steadily to their $2.7 trillion hoard of foreign currency, threaten global catastrophe if they stop, point out that the yuan has risen in value by 2.5 percent in the past several months, to which commerce secretary Yao Jian adds, "The Chinese Yuan should not be a scapegoat for United States' domestic economic problems"; and the South Koreans are urging the U.S. and the EU to rein in their criticism of the Chinese. Not exactly conducive to the sort of coordinated response the G-20 managed when the world banking system was on the brink of meltdown, unless you include in coordination the smiles at the inevitable meeting-ending photo op.

Meanwhile, the Fed's impending decision to print more money will keep U.S. interest rates so low that investors will search in other places for better yields on their investments. Places like Brazil and Thailand. Indeed, that hot money -- "hot" because it leaves at the first sign of trouble -- is already flowing into many countries, hurting exports by inflating the values of local currencies, and bidding up the price of assets to bubble-like proportions. To prevent that, affected countries are levying taxes on imported capital and erecting barriers to its exit. This denies them funds they need for economic development, and is making existing investors consider getting out while the getting is good.

Unfortunately, China's rulers can't let the yuan rise without cutting into its exports, and throwing millions out of work. Unless, of course, domestic demand rises to sop up the output of China's factories. And that can't happen until China's communist leaders do something for the workers they say they have liberated -- put in place a safety net that makes it unnecessary for its people to squirrel away half their incomes against the inevitable rainy days. Because the downtrodden workers in capitalist societies do have these benefits, they need save only 5 percent - 7 percent of their incomes, and can spend the rest.

Before condemning the national leaders for their elevation of national over international interests, consider this. The allegedly expert international institutions, each crying for more power, are not of a single mind. The European Central Bank, reflecting Germany's fear of inflation and therefore reluctant to print money, is calling for austerity now, in the hope that shrivelling deficits will restore investor confidence, make funds available at reasonable rates to bust countries such as Greece and Ireland, and encourage private sector growth. The IMF, reflecting American fears of deflation, worries that austerity-now will take so much spending out of still-fragile economies that it will trigger the dreaded double-dip -- another recession. German chancellor Angela Merkel is an ECB disciple, at least in this matter, as are the Chinese, while the Obama team -- but not the Republicans who are tipped to take control of one and possibly both houses of Congress next month -- thinks the economists at the IMF have it right.

All of this explains why Larry Lindsey, former Fed governor and chief economic adviser at the George W. Bush White House, is so pessimistic. Lindsey, now leading his eponymous consulting group, crafted the Bush tax cuts that are due to expire at year end. In a talk here in London last week, he expressed fears that political paralysis will produce a long period of, at best, very slow growth. The president wants the tax cuts retained, but not for families earning more than $250,000 per year. The Republicans and some congressional Democrats want the cuts extended for all. They won't give the president the bill he wants, and the president will veto the all-inclusive tax-cut extension they want. Result: all of the tax cuts expire, and taxes rise to turn slow growth into another recession.

Little wonder that Jamie Dimon, CEO of J.P. Morgan Chase, reports that "An overwhelming majority" of big-company corporate chiefs "believes the potential of devastating economic loss … is at an all-time high."

The opinions expressed in this commentary are solely those of the author.

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