Careful calibration of a U.S. dollar devaluation looks to be the only way to avert the sort of currency war flagged by Brazil and others, leaving G-20 powers the unenviable task of agreeing some control of the process.
The top world economies, shaken by three years of financial turmoil, are scrambling to cap or weaken their currencies in a fight over fragile global demand for exports — prompting retaliatory capital curbs and damaging trade rows.
As G-20 finance chiefs prepare to meet on October 22, they are no closer to resolution of the decade-old bugbear of global imbalances between export-driven economies — mostly developing nations such as China, but also Japan and Germany — and the big global consumers, the United States, Britain and elsewhere.
While there have been loose agreements on rebalancing over time — where emerging powers allow currencies to rise gradually — the lack of an agreed blueprint to manage the transition is already prompting unilateral actions and tit-for-tat reactions in a febrile economic and political environment.
Faced with fiscal exhaustion, hostile electorates and booming China's refusal to allow a rapid rise of the yuan, the U.S., Japan and possibly Britain seem set on another bout of money printing to reboot their ailing economies and weaken their currencies.
Fast-growing developing countries with flexible exchange rates are caught in the crossfire and are reacting fast, leading to Brazil on Monday to double taxes on foreign inflows and South Korea on Tuesday to threaten curbs on currency trading.
France, which takes G-20's rotating chair next month, has denied weekend reports of "secret negotiations" with China. But it's clear that patience in the status quo is running out.
"To avoid the damaging consequences of continued unilateral action ... a core group of major economies needs to agree urgently on a multilateral and coordinated package of policy measures," Charles Dallara, director of banking group the Institute for International Finance, said on Monday.
U.S. trade threats against China over the yuan showed the "counterproductive nature of unilateral policy," Dallara said in an open letter to the International Monetary Fund's annual meeting.
ALL HANDS TO THE PUMP
The main problem for emerging economies is much of the freshly minted "core" liquidity, chased away by depressed western interest rates, is flowing to higher overseas returns rather than strapped firms and households in America or Japan.
Their bind is a choice between standing back and accepting export-stunting currency surges and asset bubbles or to resume heavy intervention or capital controls that lead to inflation headaches or further trade distortions.
Robert Johnson, director of the Soros-funded Institute for New Economic Thinking, said G-20 needs agreement on the size and pace of the currency shifts between three main groups — the United States and major consumers; the big exporters of China, Japan and Germany; and a grouping of emerging exporters.
"There is competitive devaluation going on," said Johnson, a former director at billionaire George Soros' fund management firm and former economist at the U.S. Senate Banking Committee.
"What is called for here is a realignment of emerging countries' exchange rates vis-a-vis the developed countries — maybe 20-25 percent appreciation over the next year or two."
What emerging economies lose on export competitiveness, he reckons, they can recapture at least partially in cheaper imports for their growing middle class of consumers.
The tricky bit is how to get everyone to move together and prevent market prices snowballing or governments overreacting.
Left to their own devices markets are unlikely to deliver the gradualism desired by most governments and faith in efficient pricing is at a low ebb after the credit crisis.
And, reading the runes well, money managers already see the opportunity and are stacking bets to exploit rising pressures.
EMERGING FX RUSH
David Shairp, strategist at JPMorgan Asset Management, reckons the move to emerging currencies could now accelerate.
"One of the implicit aims of liquidity injections by the core G-4 is surely to facilitate a weakening of their currencies," he told clients this week.
Portfolio flows to emerging market equities are booming and emerging market debt denominated in local currency is currently one of the hottest fixed-income plays.
According to fund tracker EPFR, emerging market bond fund inflows, with local currency mandates taking more than half, have soared to almost $40 billion so far this year from less than $700 million in the first nine months of 2009.
Net flows to emerging market equities in the third quarter, at more than $30 billion, were some 50 percent up on the first six months of the year. And year-to-date inflows of almost $50 billion compare to a net exit from developed equity funds of almost $79 billion and an outflow of half a trillion from western cash funds.
The speed and stability of these portfolio streams may be a legitimate concern, but longer-term flows play the same tune.
ThomsonReuters data shows emerging market mergers and acquisitions this year, at $480 billion, were up 63 percent on the same period of 2009.
Crucially, this is not "hot" money.
"No one is sleeping on the job," Brazil's finance minister, Guido Mantega, said on Monday. "We risk having a trade war and that's the worry. (But) it is preferable that we take coordinated measures instead of isolated measures."
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