Currency Wars Prove Decoupling Is a Myth

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Rex Nutting

Oct. 8, 2010, 12:01 a.m. EDT · Recommend (2) · Post:

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By Rex Nutting, MarketWatch

WASHINGTON (MarketWatch) "” There's a depressing familiarity to the latest World Economic Outlook from the International Monetary Fund: The major economies of the world can still bring each other down too easily.

The rising risk of a full-blown currency war is just the most recent example of how interconnected the global economy remains. The Great Recession put an end to the notion that emerging economies had effectively decoupled from the advanced ones. Read David Callaway on the race to the bottom.

When the United States went down, so did the whole world. What happens in Detroit, Las Vegas, and New York is felt in Riga, Shanghai and Bangalore, not to mention London, Tokyo and Madrid.

The U.S., Europe and China stepped up their bickering over the valuation of China's currency, prompted by fears that competing foreign-exchange policies could hamper the global economic recovery. John Bussey discusses.

We are all in this mess together, for better or worse.

As the crisis began to unfold in 2007, there was great hope at the IMF and among other deep thinkers that the world had finally decoupled; that when the U.S. sneezed, China wouldn't get a cold. The feeling was that China, India and the other great emerging economies could finally stand on their own, without relying on ever-increasing exports to the developed world.

That delusion was shattered in 2008 and 2009, when global trade collapsed in the wake of the credit contraction in the advanced economies. Countries that relied on exports for growth were knocked around.

The emerging economies have bounced back quicker and stronger than the richest economies have. They didn't have the financial imbalances or credit problems that we did, and they had learned a lesson from their own crisis in 1997 to keep their debts down and their foreign reserves high.

For 2011, the IMF projects that the emerging economies will grow 6.4%, while the advanced economies will limp along at 2.2%. See MarketWatch's full coverage of the IMF meetings.

/quotes/comstock/11j!i:dxy0 DXY 77.49, +0.11, +0.14% U.S. dollar index The U.S. dollar has depreciated sharply vs. other major currencies in the past few months.

While some look at the relative strength of the emerging economies compared with the advanced economies as proof that they have decoupled, that's a simplistic view.

The lesson of the 2008 crisis, is that while different economies can decouple temporarily, the gravitational pull they exert on each other means that the broader ups-and-downs of growth across the globe remain highly synchronized across borders.

Two years ago, global leaders meeting at the Group of 20 summit were able to agree on coordinated actions to prevent a global depression, largely because their short-term interests coincided. Monetary and fiscal policy was loosened nearly everywhere.

But now coordination is nearly impossible. Economies have different problems now, and so they need different policies, especially on the fiscal side. Some countries need tighter policies to prevent overheating; others still need stimulus. Some need to cut sovereign debt immediately; others have time before they must act.

The biggest force working against cooperation now is, ironically, in the one area where all countries want to do the same thing "” increase exports.

The fastest way to goose your growth rate is to devalue your currency so you can sell more to your neighbors. That desire to increase exports is behind all the talk about a currency war. See more tools and data on currency markets.

Everyone sees a short-run advantage in a weaker currency, but not everyone can have a weak currency, someone has to be (relatively) strong. Not everyone can run an export-led economy, either. Someone has to buy.

The desire to devalue is creating all kinds of problems. Europe and the U.S. say China is keeping the yuan (USDCNY 6.6895, 0.0000, 0.0000%)  , also known as the renminbi, artificially weak to favor Chinese exporters. The House has passed legislation that would punish imports from China, and the Senate could approve the same measure after the election. U.S. Treasury Secretary Timothy Geithner heated up his rhetoric against Beijing, and so did the IMF. Read more about Geithner increasing the heat on China.

Meanwhile, Europe worries that the euro /quotes/comstock/21o!x:seurusd (EURUSD 1.3905, -0.0013, -0.0934%)  is appreciating too much against the dollar, thus harming Europe's producers. The Japanese have intervened in currency markets and cut interest rates again in an effort to keep the yen /quotes/comstock/21o!x:susdjpy (USDYEN 82.4200, +0.1200, +0.1458%)  from gaining too much strength.

All the policymakers have known for years what they need in the long-term to make the global economy more stable and prosperous: Balanced growth.

In practical terms, that means China (and the other exporting economies) need to save less and spend more domestically, while the U.S. (and other importing nations) need to save more and consume less. Chinese workers would benefit from higher standards of living, and American workers would benefit from having more jobs.

China needs to stop being the world's only factory, and the U.S. needs to stop being the world's only mall.

Getting to that place won't be easy, because it will take some short-term pain to achieve long-term gains. Who is willing to go first?

Rex Nutting is Washington columnist and international commentary editor for MarketWatch.

Add Comment › · Recommend (2) · Post: Alert Email Print More Rex Nutting Oct. 6, 2010 Washington hasn't done nearly enough Oct. 1, 2010 Household debt still a drag on economy Sept. 29, 2010 America's choice: Hypocrites or cowards Sept. 24, 2010 The economy can't grow forever Sept. 22, 2010 Time to stop worshiping small businesses Explore related topics Europe US Dollar Index Future - Spot Price US Dollar / Chinese Renminbi FX Spot Euro vs. US Dollar US Dollar vs. Japanese Yen Comments Screener First Take Alcoa profit spells partial relief

Alcoa's results and rosy outlook remove one of two big unknowns clouding Friday's session.

6:07 p.m. Oct. 7, 2010 | Comments: 6

Most Popular Most readMost commented John Lennon would have loved Twitter China's "?green' stocks poised to steal limelight Currency wars prove decoupling is a myth Energy-sector reversal could be for real Shanghai index soars 3.4% as trading resumes Dow industrials back off run at 11,000 Gold falls, retreating from a record high U.S. stock futures rise as claims drop Don't judge a 'book' by its cover As witching hour nears, Democrats find GOP "?scary' Reader Response »

Getting to a point where debt laden nations spend less is very easy. You just need to stop printing money. In 2008, immediately after Lehman Brothers' implosion, the savings rate skyrocketed, and the trade deficit of the USA dropped dramatically, as Americans ceased buying frivolous throw-away goods from China, and cut back on the use of oil. Permanent changes in behavior would be possible..."

- TTolstoy | 12:01 a.m. Today12:01 a.m. Oct. 8, 2010

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US Dollar / Chinese... (USDCNY) /marketstate/country/US The market is open5:53:58 am The market is closed5:53:58 am 6.6895 Change 0.0000 0.0000% Volume Real time quotes var embeddedchart1696038390Chart = new EmbeddedChart('#embeddedchart1696038390', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:USDCNY'); jQuery.data($('#embeddedchart1696038390').get(0), 'embeddedchart', embeddedchart1696038390Chart); Add to portfolio USDCNY Find a Broker Create alert /quotes/comstock/21o!x:seurusd Euro vs. US Dollar (EURUSD) /marketstate/country/US The market is open5:53:58 am The market is closed5:53:58 am 1.3905 Change -0.0013 -0.0934% Volume 0.0000 Real time quotes var embeddedchart2139702522Chart = new EmbeddedChart('#embeddedchart2139702522', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:EURUSD'); jQuery.data($('#embeddedchart2139702522').get(0), 'embeddedchart', embeddedchart2139702522Chart); Add to portfolio EURUSD Find a Broker Create alert /quotes/comstock/21o!x:susdjpy US Dollar vs. Japanese Yen (USDYEN) /marketstate/country/US The market is open5:53:58 am The market is closed5:53:58 am 82.4200 Change +0.1200 +0.1458% Volume 0.0000 Real time quotes var embeddedchart1281670570Chart = new EmbeddedChart('#embeddedchart1281670570', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:USDYEN'); jQuery.data($('#embeddedchart1281670570').get(0), 'embeddedchart', embeddedchart1281670570Chart); Add to portfolio USDYEN Find a Broker Create alert Featured Commentary » Next: Jonathan Burton's Life Savings

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