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Global crisis, Act IV: Currency turmoil starts to wreak havoc

by Noriko Hama

I don’t like to say I told you so, but I told you so. Back in July last year, I wrote in this column that the post-Lehman shock world was participating in a drama in five acts, in which the fourth was likely to be where currency turmoil hits the stage.

This is precisely what seems to be unfolding at this moment. And there are two reasons why.

Reason No. 1 is the one I referred to in the July column. This is the issue of protectionism. As I pointed out then, rising protectionism invariably leads to competitive devaluations.

This was typically the case in the 1930s. Back then, the three main players in this drama were Great Britain, France and the United States. It was Britain who started it by going off the gold standard. Freed from the shackles of gold convertibility, the pound went merrily into free-fall, thereby making it easier for Britain to dump its wares on the world market, while pricing imports out of its domestic market.

America soon followed suit. In the end, even the French, with all their love for gold and pride in their adherence to a sound currency regime, were forced to give in.

From then onward, it was a ferocious race to the bottom for exchange rates, and there could be no ultimate winner.

Competitive devaluation is a war of attrition that provides nobody with victory. The realization of this inescapable truth led the three warring parties to sign a truce, which we know as the Tripartite Currency Agreement of 1936.

The truce itself was fraught with undertones, but it did pave the way to the postwar Bretton Woods system.

Now we could do with a 21st century version of the Tripartite Agreement. Only it would have to be a four-way affair, with the U.S., China, Japan and the euro zone as the signing parties.

The problem with the current situation is that everybody wants to be an exporter and nobody wants to be an importer. The United States has been the most explicit proclaimer of this sentiment.

President Obama has actually announced his intention to double U.S. exports in five years. Meanwhile the Chinese have protested, in remarkably strong language, calls for renminbi revaluation from the United States and others.

One of the first things that Finance Minister Naoto Kan did upon replacing his predecessor Hirohisa Fujii was to declare that Japan could do with a cheaper yen. The euro zone has not openly called for a cheaper euro, but that is because they have a more pressing concern at the moment in the PIGS and their potbellied debts.

Which brings me to the second reason why currency turmoil looks like an inevitability at this point.

It is not just the PIGS who are suffering from debt bulimia. A two-headed animal that I would hereby like to christen JAPAM is by far the worst sufferer of this problem.

The JAP case is quite terminal. Its public debt-to-GDP ratio stands between 180 and 200 percent, depending on how leniently minded the calculator is inclined to be.

AM is not in much better shape either, although at more or less 100 percent of GDP, its indebtedness actually appears quite modest compared with JAP’s.

With two of the largest nations in the world sharing this condition, it would be a marvel if the foreign-exchange market wasn’t suffering from acute jitters.

Whose currency turns into worthless paper first is the issue on everybody’s mind. Given these worries, plus currency warfare in the offing, turmoil might turn out to be too modest a word to illustrate Act IV of our ongoing global saga.

Noriko Hama is an economist and a professor at Doshisha University Graduate School of Business.