One of the most striking features of policy coordination in the post-financial crisis period was the manner in which most major countries desisted from engaging in serious forms of trade protectionism, even when faced with rising unemployment domestically. That consensus which staved off a potential race to the bottom, however, seems now to be fading rapidly as the world descends into what Brazilian finance minister Guido Mantega has quite rightly termed ?international currency wars.? A series of major and relatively minor economies, including the US, Japan, Thailand and Colombia, have taken deliberate steps to weaken their currencies in order to boost growth. The question, of course, is why now?

For one, the recovery of economic growth in a number of countries, including the US and Japan and also certain emerging economies, has been far from robust. That sort of scenario worries politicians and policymakers and deliberately undervaluing the currency is an old-fashioned way to boost growth via exports. The problem, of course, is that growth engineered in this fashion comes at another country?s expense (beggar-thy-neighbour). And sooner, rather than later, other countries will engage in competitive devaluations that will wipe out the gains, and inflict a cost, significantly in terms of inflation.

Needless to say policymakers in the US, Japan, Thailand, etc, are perfectly aware of this. But they would argue that their response is being forced by China?s continued insistence on keeping the yuan undervalued. Of course, the undervaluation of the yuan preceded the global crisis, and is therefore not something that the Chinese have resorted to as a crisis strategy. However, a policy that other countries could tolerate in the time of global boom has become intolerable in the bust?there is a strong feeling that China cannot be allowed to take all the gains from exports at the cost of others. The estimates of how much of the yuan is undervalued vary but in real exchange rate terms, it could be anything between 25% and 40%.

The curious thing is why the US and other countries are not willing and able to force China into revaluing its exchange rate. After all, Japan was ?persuaded? to let the yen appreciate in the 1980s when its current account surplus peaked at between 4-5% (compared to China?s peak of 10% in 2008) and when growth was around just 5% (China?s is almost in double digits). Surjit Bhalla?s forthcoming book Devaluing to Prosperity has a brilliant chapter explaining this irony. Bhalla makes the argument that it just may be in the interest of

US business (particularly I-banks) to let China continue its distorted policies because they do not directly compete with Chinese firms in the way they did with Japanese firms two decades ago. On the contrary, they prosper when China does.

There may also be another reason why some countries would rather devalue themselves than force China to revalue. The US and Japan, in particular, may be using devaluation (through lower interest rates and printing money) as a method to engineer some inflation. A carefully engineered inflation (if that?s indeed possible) would help cut both private and public debt rapidly in these highly indebted countries. Of course, that involves a massive transfer away from savers to borrowers, and risks creating an inflationary spiral that may be difficult to control.

Amidst these misguided policy interventions by some countries, other economies are facing adverse consequences. Ironically, these are the countries that have recovered smartly from the crisis. Brazil is a prime example. One of the consequences of the low interest rate-easy cash regime in the US and other advanced economies is that capital is pouring into countries like Brazil (and indeed India) because of the higher interest rates (and better returns offered in high growth economies) which is putting upward pressure on the exchange rate of these countries. That is rendering their exports uncompetitive. Countries like Brazil may, therefore, be forced into making their own interventions, including restrictions on capital flows, which aren?t necessarily good for them.

The currency wars are set to be a serious test for the much celebrated G-20 when it meets in South Korea in November. Coordinating stimulus was the easy bit, but can coordination work when interests conflict?

dhiraj.nayyar@expressindia.com