(eca003) Fears of currency war grow as East-West divide deepens (Feature)

By Chris Cermak Oct 7, 2010, 17:36 GMT

Washington - The United States, Europe and Japan are faced with the depressing dilemma of weak economic recovery with a lack of policy tools to do anything about it.

To make matters worse, they can enviously watch emerging Asian and Latin American powers, which are growing at full steam and showing few permanent scars from last year's deep global recession.

This dynamic might explain the latest feud over exchange rates, a spat that some fear could quickly spiral out of control. Japan has intervened twice in the last month to weaken the yen, while US lawmakers have backed a measure that could lead to import tariffs in response to China's undervalued yuan.

'Things are getting hotter, faster than many people had anticipated, in terms of countries intervening to manage their exchange rates,' said Menzie Chinn, an economics professor at the University of Wisconsin. 'That puts a little more urgency on the issue.'

Exchange rates - and the broader topic of 'rebalancing growth' - will top the agenda when world finance ministers gather this week in Washington for annual meetings of the International Monetary Fund (IMF) and World Bank.

The IMF, in its latest report on the global economy, painted a picture of a recovery that has become increasingly uneven. But IMF Managing Director Dominique Srauss-Kahn on Thursday warned countries against provoking a currency war in order to close the gap.

'It is true to say that many (countries) do consider their currency as a weapon, and that is certainly not for the good of the global economy,' Strauss-Kahn said.

Advanced economies were forecast by the IMF to grow by 2.7 per cent this year and slow even further to 2.2 per cent in 2011. Unemployment rates in the United States and eurozone were predicted to hover near 10 per cent in both years.

Compare that to developing countries, where the IMF predicted growth will surge 7.1 per cent this year and 6.4 per cent in 2011. China's economy is projected to grow 10.5 per cent this year, India's 9.7 per cent and Brazil's 7.5 per cent.

Hamstrung by massive budget deficits, most wealthy countries have few options but to ride out the economic slide. Many governments, especially in Europe and Japan, have been forced to begin cutting spending with their economies still sputtering.

'The main challenge of advanced countries is fiscal consolidation,' IMF chief economist Olivier Blanchard said Wednesday.

Budgets cuts were needed now, even if there was 'no question' that lower spending would reduce growth in the immediate future.

Faced with weakened economies and unpopular spending cuts, US President Barack Obama and other Western leaders have begun stepping up the pressure on China and other emerging powers to raise the value of their currencies.

The US and Europe have long argued that China's yuan is undervalued, giving the Asian powerhouse an unfair trade advantage. Rich-world governments hope that a shift in exchange rates will raise exports and provide a much-needed boost to their economies.

US Treasury Secretary Timothy Geithner warned Wednesday that efforts by emerging powers to hold down their currency values are a 'damaging dynamic' that threatens the global recovery.

'For too long, many countries oriented their economies toward producing for export rather than consuming at home, counting on the United States to import many more of their goods and services than they bought of ours,' Geithner said in a speech at the Washington- based Brookings Institution.

China has so far resisted the pressure. Premier Wen Jiabao has warned that a sharp rise in the yuan would spark a wave of bankruptcies and factory closures. At an Asian-European summit this week, he said that exchange rates should remain 'relatively stable.'

Others argue that the yuan's appreciation is in China's own interest, forcing the Asian power to shift towards domestic consumers as demand from weakening industrial economies dries up.

'The dependence on exports is just something of a development mode that has outlived its usefulness,' Chinn said. '(China) can't rely upon that engine of growth.'

Yet an appreciation of the yuan alone might have little impact on US and Europe's trade balances, as demand would likely shift to other Asian economies that rely on exports.

'Rebalancing requires the depreciation of many emerging market currencies against many advanced country currencies,' Blanchard said.

That broader shift will be debated by the world's finance ministers in Washington and will continue in November at a Group of 20 summit in South Korea.

Blanchard cautioned: 'We're just at the beginning of the process.'

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