Fighting the Currency War

currency warThere is a new sheriff in the proverbial global village, recruited to keep the peace in the currency markets. It is 66 years old and, since the crash of 2008, it has played a crucial role in reshaping the global economy. It is the International Monetary Fund (IMF) and its latest mission: the containment of what was lately dubbed the “currency war.”

I know it sounds very militant, but perhaps the terminology accurately describes the tension building up almost to the boiling point, as world bankers and officials congregated in Washington this past weekend for the annual IMF and World Bank meeting. What is the fuss all about? Well, it is more than a fuss.

The volatility in the currency markets has been tremendous lately, as emerging markets, fast growing and tired of being apologetic, seek more control over their own currencies. In contrast, the developed world does not want to relinquish that control; instead, the developed world wants emerging markets’ currencies to float freely. This, at least in the case of China, means letting emerging markets’ currencies freely appreciate. If this is not done, the developed world is in a mood to retaliate, particularly against the U.S., starting trade wars, and who knows what else.

At this point, the reaching of a globally acceptable agreement that would calm the currency markets has been elusive. The Chinese are adamant that the appreciating yuan would create domestic factory closings and social instability. At the same time, the Fed appears to have let go of the idea of additional monetary stimulus, as that would have an adverse impact on the dollar. Reaching what appears to be an impasse, the world’s economic elite have reached out to the IMF, hoping it could bring some calm and reason to the playing field.

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Canada’s Finance Minister, Jim Flaherty, commented, “We’re all agreed we need to move toward co-operation on exchange rates. The IMF has an important role. The IMF can encourage co-operation on that specific issue of exchange rates.”

What the world’s central bankers and economists are seeking from the IMF is to try to put in place some sort of “governable guidelines,” which would explain the rules of engagement for situations when government intervention in the currency markets is needed beyond merely subsidizing the exporters. But to figure out such guidelines in an impartial manner, the U.S. Treasury Department or the Chinese Finance Ministry would hardly do. That is why the world has called on the IMF.

What 24 countries comprising the IMF’s steering committee have asked of the fund’s management is to complete an in-depth analysis of the economic forces currently lashing the currency markets. Included are the record-high accumulations of foreign exchange reserves and the long-term impact, presumed dangerous, of exports on steroids from countries such as China, Japan and Germany, which are not focusing on ramping up their internal demand.

None of these concerns are anything new. And it is not as if the world’s central bankers have not asked the IMF to reconcile their differing views before. What is different this time around is that the IMF was given an actual green light and the necessary tools to create the bridges the currency markets need right now. This has now moved beyond a mere conversation among peers and certainly beyond the IMF’s role as a crisis lender.

That said, there are plenty of challenges that the IMF may face along the way. The institution is not a beloved one. In fact, because of its strict terms under which it issues the loans, the IMF is laboring under a legacy of distrust in most emerging markets. Additionally, there are legitimate questions about how much authority the IMF really has, considering that many countries have grown rich enough not to need its loans anymore. How much of a balanced solution the IMF can bring to the table remains to be seen, of course. However, in spite of its shortcomings, in all likelihood, the IMF remains the right institution to negotiate this particular conundrum developing in the currency markets.