Global financial crisis and currency war

As one of the founders of the Bretton Woods institutions, Harry Dexter White once commented: “Currency warfare is the most destructive form of economic warfare. Economic warfare eventually brings war”.

by Raul de Sagastizabal – April 2009

The world is approaching its first “lost biennium”, with devastating results in terms of growth and development, and a politically unpredictable ending.

Whatever the results of the actions taken – or promised – by the G-20 or any other “G” Summit, it seems unlikely that any short-term measure can assuage the impacts of the crisis on the real economy.

Nor can it be expected that any political statement whatsoever can check a crisis whose evolution no one is able to fancy.

Considering the fact that mortgage-backed securities are but a segment of asset-backed securities (a category that includes personal- and consumer loan-, credit card receivable-, and car-loan-backed securities), all of which are ultimately based on demand and consumption, we are only to sit back and expect the next crisis waves, where people just stop paying back their car loans or credit card bills, limit their expenditures, refrain from accepting credit, or simply save, rather than purchase.

Considering, besides, the fact that a proportion of pension funds, private or sovereign investment funds, and even multilateral financing institutions’ investments are denominated in such asset-backed securities, and the fact that such assets and other structured financial instruments guarantee the loans of large corporations and no one can ascertain their “toxicity” levels, the real extent of the crisis is simply unknown.

The crisis has already been on the stage for two years, and its outlook is worsening steadily.

Once upon a time, as stories tell, there was a global financial crisis prompted by a dangerous combination of speculation and greediness, open and active advocacy of capital market opening to foreign banks and innovative financial instruments, combined with lack of control and regulation.

Guilty parties are easily found: bankers and private financial institutions, with the coverage of credit risk evaluators, credit multilateral agencies actively promoting capital market liberalization and structured financial instruments, as well as national governments, who decide both the assets its sovereign funds are to be invested in, and domestic regulation and controls.

The billion dollars delivered to the banking entities during consecutive rescue operations reflect the scale of the problem in the industrialized countries. The choice of the G-20 as the forum for a concerted exit prompts me to surmise the leaders of the great nations are unable to draw a response from closer fora, such as the G-5 or the G-8 – or have simply staged a cost-sharing strategy for a period where the most intense global impacts make themselves felt.

Developing countries and transition economies, many of which are not responsible for the crisis or can contribute to its solution will be paying for the real culprits with more poor and unemployed people, and fresh indebtedness, in exchange for promises for larger decision-making power somewhere between 2010 and 2011.

From the developing countries of the Americas two signals are to be considered. Brazil will provide US$10 billion to recapitalize the IMF, while Mexico is requesting a credit line from the Fund, on the amount of US$47 billion. A third sign to be borne in mind is the lack of a political forum enabling the Region to operate as a block more effectively than through individual countries to try and avoid the more serious consequences of the downturn and get something in exchange of footing the bill for other actors.

In turn, China – the third economy of the world – is becoming a stronger decision-maker, and demanding a seat in the small table. In exchange, it is prepared to provide more resources to revitalize the global economy, while maintaining its new de facto trade leadership strategy through bilateral and regional agreements and swaps.

During the last three months, the Asian giant has signed six swap agreements totaling over US$100 billion, become a member country of the Inter-American Development Bank and led the claims for a reform of IMF conditionality and voting powers (China has only 3.67 percent voting power, while United States has 16.83 percent).

The industrial and not-so-industrial nations put the blame for the crisis on the United States, which contend American consumption cannot be the only growth engine, and drew the world during the recent upswing. However, this crisis shows many shared responsibilities and guilts.

The current crisis was the most predictable one in recent history. All too many warnings were uttered about growth rates unsustainability and about the storm in the offing.

However, as remarked to a reporter by Charles Prince, President and Director General of Citigroup in early July, 2007, “as long as the music is playing, you’ve got to get up and dance”. This is as valid for the private sector as for the public sector.

However, the crisis roots are now relatively irrelevant, save, at most, to avoid them in the future. Even that is questionable, since the talk is about designing new rules and institutions that reduce systemic risks, “without imposing unnecessary burdens and stifling innovation”.

The urgent job, in London, at this stage, was stopping the fall.

Meanwhile, an economic and monetary debate – almost a monetary war – has been staged around the crisis. Some world leaders mention a new economic order; other leaders foresee a new multipolar world order.

Since early March, a series of obstacles dotted the road to the London summit. This was particularly apparent in terms of immediate measures, with the US demanding large fiscal stimuli measures and rejecting the idea of creating a super-regulator, while the EU opposed the idea of injecting public monies in the economy, and only stressed added domestic and international regulation and supervision.

Other debates, also significant, surfaced, on the role of China in the decision table; the urgent financial needs of some emerging economies and developing countries, fiscal havens, and the reform of the multilateral credit agencies.

Also some surprises, such as the document from the Governor of the Bank of China, with the proposal to create a new super monetary reserve unit, maybe the IMF’s special drawing right (SDR). Such proposal was immediately supported by Russia, which had advanced a similar request considered legitimate by the IMF and quickly adopted by Nobel Prize winner Joseph Stiglitz.From his UN Commission, Stiglitz suggests the new unit could be in use in just 12 months-time.

Another surprise, even bigger, is the unanimous coincidence in refloating the IMF and the World Bank. Both multilateral credit organizations have been undergoing a decade-long process of loss of prestige after so many failures in the areas of crisis prevention and crisis solution, corruption episodes and dubious results in terms of development – on top of being part of the problem.

The G-20 leaders agreed to increase the resources of both institutions to put out the fire in the emerging economies and developing countries, and promised changes in terms of conditionality and vote power. The scale of the resource increase denotes the seriousness of the impacts foreseen; a serious reform of multilateral development banks, however, will remain unresolved.

In the meantime, several countries started a competitive devaluation process, while others adopted many protectionist measures.

By March 30, no winners could be seen in the scenario.

In an attempt to reduce the scale of the summit differences, President Obama stressed the cost of the measures proposed and pointed out that taxpayers demand precise information on the use of such monies, and do not feel comfortable in seeing the Government keeps using their money to rescue the banks, which, in their view, are responsible for this catastrophe, without any consequence in the solution of their concrete problems.

Obama remarked the USA could not solve the issue by themselves, and had come to the summit in search for solutions, rather than culprits, and stated that people expected firm concerted efforts. He remarked, nonetheless, that countries could not base on the voracity of the American consumption their expectations for an increase of their export incomes.

In the struggle between fiscal stimulus and more regulation, Obama was supported by Great Britain against the Germany-France Axis, and other countries, such as those of the BRIC block (Brazil, Russia, India, and China) shared his views on boosting demand and consumption to reactivate trade and the economy at large.

The die was cast: the worst scenario, in London, was that of an even more serious situation brought about by the participants themselves. Urgency prevailed behind the scenes, and fear finally led to a compromise.

On granting each side part of its demands, the participants recognized shared responsibilities. In this sense, the USA won – they left the summit as part of the solution, rather than being considered as the sole guilty party.

However, the compromise was an obvious provisional solution; a break in times of urgency.

None of the measures agreed being immediate, the only possible expectation is that they be the departure point for a reversal of the global disaster process.

In any case, power spaces will again be wrangled over, in a new world order.

The Second World War was followed by the Cold War and its bipolar domination order; the fall of the Berlin Wall brought about a unipolar order led by the United States as a planetary power, and until recent times globalization was conceived as a scenario for supranational military, economic and political institutions – kind of a world government. Now a multipolar world seems to be emerging, with three big blocks in the horizon: the Anglo-Saxon one; that of Germany and Russia + France, and the block formed by China and its Asian neighbors. Each pole seems ready to fight for its space and assumably drag to its side the smaller countries, which would only be able to choose the block they would be aligned with. Let us take a look to the process leading to this new agenda, and the moves of the main actors in these tumultuous times. This is a minimum compilation of selected documents published by the large media. Read in isolation, each item seems just one more item in the informative oversupply. Together, they herald the terms of the future struggle.

September 26 (2008)

German Leaders Blame US for Financial Crisis

“The United States, and let me emphasize, the United States is solely to be blamed for the financial crisis. They are the cause for the crisis and it is not Europe and it is not the Federal Republic of Germany.”

The finance minister also predicted, “The world will never be as it was before the crisis; the financial system will become more multipolar. Wall Street will never be what it was.” 

February 6 (2009)

Sino-US trade war will worsen global crisis

There are rising worries among the international community that China and the United States are going to a trade war at a time when the world desperately needs concerted efforts to tackle the escalating global financial crisis. US Treasury Secretary Tim Geithner accused China of currency manipulation. China will not tolerate US intervention in its exchange rate policymaking.

March 10

Stiglitz Calls for Global Solution to Crisis

“The UN is the only institution that can push through the necessary measures. “We need a new start.”

March 12

Swiss action sparks talk of currency war

The Swiss National Bank moved to weaken the Swiss franc on Thursday, the first time a big central bank has intervened in the foreign exchange markets since Japan sought to weaken the yen in 2004.

“Let the currency wars begin,” said Chris Turner at ING Financial Markets.

Countries around the world faced with the constraint of zero interest rate levels might feel it was acceptable to intervene to weaken their currencies in order to ease monetary conditions, he said, adding that other export-dependent economies such as Japan would “probably be at the head of the queue”.

March 16

Russia proposes creation of global super-reserve currency

“The creation of a supra-national reserve currency that will be issued by international financial institutions.”

“The decisions we shall make at the London summit must be not only adequate to the current situation, but also meet the requirements of a new, post-crisis world.” 

March 17

Protectionist Measures Show Worrisome Rise Since Beginning of Financial Crisis

Since G-20 leaders signed a pledge in November 2008 to avoid protectionist measures, several countries, including 17 of the G-20, have implemented 47 measures that restrict trade at the expense of other countries, a new World Bank study shows.

“Leaders must not heed the siren-song of protectionist fixes, whether for trade, stimulus packages, or bailouts,” said World Bank Group President Robert B. Zoellick. “Economic isolationism can lead to a negative spiral of events such as those we saw in the 1930s, which made a bad situation much, much worse.”

March 19

Values for a Sustainable World Economy

The current global financial crisis embodies a chance for a new economic order, argue German Chancellor Angela Merkel and Dutch Prime Minister Jan Peter Balkenende. 

March 22

News analysis: EU takes different approach to financial crisis

US officials had repeatedly called on the EU countries to step up fiscal stimulus to boost demand as a way out for the current financial crisis.

On the eve of the EU summit, Merkel and French President Nicolas Sarkozy emphasize that the EU common position at the London summit should focus on building a new international financial system. Their position has been taken by all EU leaders.

At a G20 finance ministers’ and central bankers’ meeting on March 14, Brazil, Russia, India and China – known as “BRIC” countries – called for immediate measures to expand the four nations’ powers in the IMF. There seemed to be disagreements even within the EU’s big three – Britain, France and Germany. Germany and France now also worry that Britain might be leaning toward the United States at the London summit, thus undermining the common EU position.

March 23

Economic crisis dire, risk of unrest and war

The crisis will push millions into poverty and unemployment, risking social unrest and even war, and urgent action is required, IMF Managing Director Dominique Strauss-Kahn said.

“All this will affect dramatically unemployment and beyond unemployment for many countries it will be at the roots of social unrest, some threat to democracy, and may be for some cases it can also end in war,” he said.

March 23

Reform the International Monetary System – Governor Zhou Xiaochuan

The outbreak of the current crisis and its spillover in the world have confronted us with a long-existing but still unanswered question, i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF?

Entrusting part of the member countries’ reserve to the centralized management of the IMF will not only enhance the international community’s ability to address the crisis and maintain the stability of the international monetary and financial system, but also significantly strengthen the role of the SDR.

March 24

China Takes Aim at Dollar

China called for the creation of a new currency to eventually replace the dollar as the world’s standard, proposing a sweeping overhaul of global finance that reflects developing nations’ growing unhappiness with the US role in the world economy.

The unusual proposal, made by central bank governor Zhou Xiaochuan in an essay released Monday in Beijing, is part of China’s increasingly assertive approach to shaping the global response to the financial crisis.

Zhou’s proposal comes amid preparations for a summit of the world’s industrial and developing nations, the Group of 20, in London next week. At past such meetings, developed nations have criticized China’s economic and currency policies.

This time, China is on the offensive, backed by other emerging economies such as Russia in making clear they want a global economic order less dominated by the US and other wealthy nations.

Monday’s proposal follows a similar one Russia made this month during preparations for the G20 meeting. Like China, Russia recommended that the International Monetary Fund might issue the currency, and emphasized the need to update “the obsolescent unipolar world economic order.”

March 25

Talks on new world reserve currency ‘legitimate’: IMF chief

IMF managing director Dominique Strauss-Kahn said Wednesday that talks on a new world reserve currency to replace the US dollar were “legitimate” and could take place “in the coming months.”

March 27

Angela Merkel: “When the crisis is over, one will have to shuffle again and see who came out strengthened”.

The Chancellor rejects USA’s idea that her nation needs to strengthen domestic demand to help restore the balance in an asymmetric world economy.

More crucial for the future, in Merkel’s opinion, is making sure the German companies do not lose their technologic edge. “So will China do. So will the USA do”.

We are talking about building a new global financial market architecture and we will not be able to finish this in London … We will definitely need to meet again. 

March 30

New reserve currency could come quickly-Stiglitz

A reserve currency system based on an IMF unit instead of the US dollar, a proposal floated by China, could be phased in within a year, Nobel Prize-winning economist Joseph Stiglitz said on Thursday.

“The dollar reserve system is deflationary, unstable and it also has some inequity associated with it” Stiglitz said.

March 31

Strengthen Regional Financial Cooperation and Actively Conduct Currency Swap PBC

Since the outbreak of the international financial crisis, China’s central bank has been actively engaged in cooperation initiatives at the international and regional level, including the signing of a few bilateral currency swap agreements with neighboring countries and regions, which has boosted the confidence and capability of all parties concerned to handle the ongoing crisis.

Until recently, the PBC has signed 6 bilateral currency swap agreements with other central banks (monetary authorities) totaling 650 billion yuan, including the framework agreement signed with the Bank of Korea involving 180 billion yuan on December 12, 2008, the formal agreement signed with the Hong Kong Monetary Authority involving 200 billion yuan on January 20, 2009, the formal agreement signed with the Bank Negara Malaysia involving 80 billion yuan on February 8, 2009, the formal agreement signed with the National Bank of the Republic of Belarus involving 20 billion yuan on March 11, 2009, and the formal agreement signed with the Bank Indonesia involving 100 billion yuan on March 23, 2009, on March 29, 2009 in the sideline of the Annual Meeting of the Inter-American Development Bank Group, Governor Zhou Xiaochuan signed with the Central Bank of Argentina a framework agreement on currency swap involving 70 billion yuan, which will be soon followed by a formal agreement.

April 1

Beijing strikes in currency war as Argentina to use yuan

China and Argentina have agreed to swap to avoid using US dollars in trade between the nations, as Beijing ratchets up the pressure on Washington.

In a bid to force the US to relax its grip on global financial institutions, China yesterday announced a deal with Argentine.

China has been pushing to end the dollar’s international dominance as a currency. Royal Bank of Scotland economist Ben Simpfendorfer said a “de facto adoption of the yuan as an Asian currency unit” may be on the cards, with China becoming the major trading partner of most other Asian countries.

April 2

Today’s G20 deal will solve financial crisis, claims Gordon Brown

“This is the day that the world came together to fight back against the global recession,” claims PM as G20 agrees plan for economic recovery.

“I think a new world order is emerging with the foundation of a new progressive era of international cooperation,” Brown said.

The French leader said a new era had begun in the world of global finance: “Since Bretton Woods, the world has been living on a financial model, the Anglo-Saxon model – it’s not my place to criticize it; it has its advantages. Clearly, today, a page has been turned”. 

April 3

“The IMF is back”

The title is not just a slogan, but the opening sentence used by Dominique Strauss-Kahn, the exultant Managing Director of the International Monetary Fund, to describe the new role of the polemic financial institution after the G-20 Summit.

Do you still believe the crisis can provoke a social revolt?

What I said was that our ability to find a way out of the crisis would depend on the contents of the decision adopted by the leaders. If nothing were done, consequences such as revolts, threats to democracy, or civil warfare could take place in poor countries. I am confident the decision adopted is the evidence we are no longer at the crossroads – our position has improved.

April 3

Interview: President Lula da Silva: “We can change if we want to change”

The Brazilian leader spoke not only of a new economic order, but also of a new political scenario where Latin America will play a significant role.

“Each finance fund will have to generate a clothing item, a shoe, a car, a shirt – this is the reason why the financial system exists, rather than selling paper shares”.

“What do you feel our children and grandchildren will get from this summit? In other words, will it be one of the many summits held, or an inflection point for the world economy, in terms of the way the world will be reorganized?”

“I pray God that my grandchildren be not ashamed of this summit in 15 or 20 years from now”.

April 4

President Obama Speaks at G-20 Summit

“I do not buy into the notion that America can’t lead in the world,” Obama said, but he added that it is “very important for us to be able to forge partnerships as opposed to dictating solutions.”

“In life there are no guarantees; in economics there are no guarantees. There are always risks involved. I have no doubt, though, that the steps that have been taken are critical to preventing us sliding into a depression.”

The steps “were necessary,” Obama said. “Whether they were sufficient, we’ve got to wait and see.”