x Abu Dhabi, UAEWednesday 24 January 2018

Compromise the big hope for G20 summit

Financial leaders meet this week in South Korea but simmering currency tensions and differing economic opinions may scuttle the chances of agreements.

The Group of 20 leading and emerging economies gathers in South Korea this week against a backdrop of heightened uncertainty in global financial markets.

Many commentators and policymakers have speculated openly about the possible outbreak of currency wars between the participants, especially the US and China, each of which blames the other for the world economic problems.

Such an eruption of financial hostilities would endanger the economic recovery after the most serious financial crisis the world has experienced in 80 years.

Robert Zoellick, the president of the World Bank, has tried to calm the atmosphere with a call for co-operation at the G20 meeting and a return to a modified version of the "gold standard" that governed international financial dealings and currency movements until it was abandoned in 1971.

The National looks at how countries have reached the brink of currency warfare and what the prospects are for a peaceful solution.

Why are G20 nations at loggerheads over world finance?

The current impasse is a direct result of the financial crisis which exploded on the world in 2008 and the resulting downturn in the global economy. Although the threat of long-term global recession has been avoided and there has been a recovery, it has been patchy and uneven, with China, India and other Asian economies leading the way, ahead of the traditional economic "great powers" of Europe and the US. This has led some economists to talk about a "new world order" in which Asian countries will gradually supplant the West as the leading engines for global growth. Western countries have been forced to take radical measures to revive their economies. In Europe, this has led to austerity packages to cut government spending and state debt. The US has relied mainly on quantitative easing (QE) measures that aim to stimulate growth by injecting dollars into the economy. The most recent package involved a total injection of US$600 billion (Dh2.2 trillion) via the purchase of government bonds. It was heavily criticised in China and Germany.

Why are people talking about "currency wars"?

Both China and Germany are "lender" nations, in contrast to the "debtor" countries such as the US, UK and several other European states. This means they make their economic living by exporting goods and services, facilitated by competitive labour markets and exchange rates. The QE programmes in the US have the result of making the dollar cheaper by flooding the world with dollar-denominated assets. While US manufacturers feel the benefit of the low dollar, which makes it easier to sell their services abroad, other countries, specifically the "lenders", feel the pinch in competing with US exporters. China, the biggest exporting country in the world, will feel the effects most keenly. A weak yuan is crucial to China's policy of export-led growth, which has been the mainstay of the country's dynamic economy, now the second-largest in the world. The US believes China has been keeping the yuan artificially low, and has threatened protective measures if it is not allowed to appreciate. Hence "currency wars".

Who is to blame - the US or China?

It depends if you are in Washington or Beijing. Many economists have some sympathy with US claims about the "artificially" weak yuan and other countries, such as the big exporters Japan and Germany, think the Chinese should allow their currency to appreciate to some degree. But not many think the solution is the financial blunderbuss of huge QE. China, in turn, says QE is "artificially" driving down the dollar and warns of serious social and political consequences if its exporting industries are hampered.

What would a return to a "gold standard" involve?

The gold standard was the financial system that governed international trade in varying forms until 1971. The model was the 1944 Bretton WoodsAgreement reached by global financiers in the eponymous New Hampshire town. The system allowed foreign exchange rates to move only within fixed parameters against other currencies and was underpinned by a US commitment to convertibility of the dollar into gold. Foreign governments and corporations holding dollars, the world's effective "reserve" currency, could ask for them to be changed to gold by the US. When, in the late 1960s, the French did exactly that on a large scale, then president Richard Nixon halted convertibility, the so-called "Nixon shock". Since then, world currencies have in theory been allowed to float more or less freely. Mr Zoellick believes a return to gold convertibility in some form would be a stabilising factor and advocates using gold as "an international reference point" for the leading currencies: the dollar, yen, euro, pound and yuan. He thinks this would reflect "emerging economic conditions", since many markets already use gold as an alternative monetary asset.

What are the chances of Mr Zoellick's plans being adopted for long-term co-operation in international financial markets?

The US is likely to resist plans to return to the gold standard, at least in its purest form. It would halt its QE strategy by limiting the amount of financial stimulus available to the amount of gold held by the US authorities. As the value of all the gold ever mined is less than the dollars circulating in the US alone, this would clearly be impractical. It would not appear to be in China's interests either. Its big financial asset is its holding of dollars and dollar-denominated assets such as Treasury bills. Gold convertibility would reduce their value. If, however, Mr Zoellick was able to mark his new gold standard against all the main currencies, it might have a chance of success by spreading the pain around. But persuading all those policymakers to agree would be a very difficult assignment. The clear winners would be holders of gold and gold mining companies, as well as non-combatants in the currency wars that have significant deposits, such as Russia and South Africa. The price of gold has continued to rise despite the global financial problems and has more than doubled over the past five years, reinforcing its reputation as a "safe haven" in troubled times.

What are the consequences if no solution is found?

Convincing G20 finance ministers, as well as representatives from the IMF, World Bank and other institutions, to all agree in South Korea will be difficult. So a deal along Mr Zoellick's lines looks virtually impossible. It remains to be seen how the US will react in the absence of a co-operative consensus. But some in the US are advocating strong measures against China if the yuan is not allowed to appreciate: trade tariffs and quotas against Chinese imports, acceleration of other QE measures, even embargoes, are possible. For its part, China has the ultimate weapon in its arsenal: the ability to wreck the US financial system by dumping all its dollar assets. But, because that would inflict serious harm on China's national finances, too, such as move is unlikely to happen. The most likely - and worrying outcome - is a prolonged stand-off, which would damage world economic growth at the worst possible time and could exacerbate rising political tensions between the US and China.

fkane@thenational.ae