IMF meeting ducks currency war issue

Finance ministers and central bank governors in Washington at the IMF/World Bank annual meetings ended their discussions with much whimpering, and a whimper of a final communiqu? There was much talk of 'war' - currency war, trade war - in the hallways and hotels, if not yet in the formal forums, but in the end, the so-called leaders of the financial world just tried to wish the main issue away.

It will not work. Potential catastrophe looms unless someone can persuade China that growing economic power should be matched with growing global responsibility, and persuade the United States to cool its rhetoric.

On the critical medium-term question of the 'governance' of the IMF - meaning who gets to call the shots through the shareholdings and with seats at the top table - it is hard to characterise the posturings: perhaps a children's game of musical chairs, or shifting the deckchairs on the Titanic.

The communique of the IMF's key committee was wishy-washy, full of pious blah-blah, and without a single mention of 'dollar' or 'yuan' or even 'currencies'. It said in the final paragraph of a three-page statement: 'While the international monetary system has proved resilient, tensions and vulnerabilities remain as a result of widening global imbalances, continued volatile capital flows, exchange rate movements, and issues related to the supply and accumulation of official reserves.' It called upon the IMF to 'deepen its work' on these issues 'including in-depth studies to help increase the effectiveness of policies to manage capital flows'.

What a load of verbal diarrhoea! The IMF has been studying these issues in depth for several years, but member governments - which control the IMF as its shareholders - have refused to take action. Passing the ball back to the IMF without giving it the power to act on its recommendations is potentially dangerous.

When he was asked why the final communique was so weak, IMF managing director Dominique Strauss-Kahn replied wearily: 'There is only one obstacle, and that is an agreement of the members.' He added: 'The language is not going to change things. Policies have to be adapted.' But Strauss-Kahn, a politician and former French finance minister, also said: 'There is no way to believe that global growth can be rebalanced without some changes in currency values.'

The US and China have become the public protagonists on the question of currencies, with American Treasury Secretary Tim Geithner using the IMF forum to step up the pressure claiming that yuan is undervalued and that this must be put right. Given next month's midterm elections, the hawkish mood in congress and President Barack Obama and his Democrats facing losses in both houses, he has little option.

It is not clear what the next US move could be without firing the first shots in a potentially disastrous currency and trade war. In London, billionaire George Soros warned that a currency war, with China against the rest of the world, could lead to the collapse of the world economy.

China is equally firm, driven by both a fear of being seen to be pushed around and by worries that a rapid appreciation of the yuan would eat into its exports and create unemployment and social unrest.

The Europeans and Japan are also concerned about damage to their currencies, exports and jobs.

Japan spent billions of dollars in an effort to stop the rise of the yen. Finance minister Yoshihiko Noda told the Japanese press that other members of the industrialised nations had understood Tokyo's intervention. Yes, but did Noda understand? The yen was at 82.3 against the US dollar when he intervened, and slipped to 85, but yesterday it was 81.80 and galloping towards 80 and a record post-war high against the dollar. Noda has obviously been nodding off if he hasn't noticed that his intervention amounted to a badly spent few billion.

A succession of other countries have joined a growing queue to express their fears. Korn Chatikavanij, finance minister of Thailand, which has successfully weathered a 10 per cent revaluation of the baht this year, and 25 per cent over five years, said: 'There is every fundamental reason our currency should appreciate. But if we adjust, everybody should adjust. We need to see the major economies sit down and talk about it like adults.' His voice of common sense was lost in the hubbub.

There are several problems preventing proper corrective action or even a cooling of passions. One is the size of the daily foreign exchange market: US$4 trillion a day is a lot of liquidity swooshing round and can easily become a noxious flood for any one currency. Another is that are not enough places for the money to go. If sentiment is against the US dollar, as it has been, then the euro and the yen are the beneficiaries - or the victims - of the hot money flows.

If Beijing diversifies out of US dollars and into yen - as it has recently - that not only adds variety to its holdings, but strengthens the yen. In this, China has a double advantage through its currency controls. Chinese Premier Wen Jiabao has stressed China's support for Greece in buying its bonds, but that will also have the effect of strengthening the euro to China's advantage.

There is no doubt that China has been stubborn, but there has also been a lot of unimaginative thinking and reporting. American economists and congressmen have complained bitterly that the yuan is undervalued and cited figures of 25 to 40 and even 50 per cent for the extent. Reporters from China have responded that a 20 to 30 per cent yuan revaluation would sink China's exports and jobs. Yes, of course, a sudden appreciation would be damaging, but what about a 10 per cent revaluation, as Soros has suggested, or 15 per cent over a year?

It is disheartening that the IMF has been warning for years that the yuan is undervalued, but the problem has grown apace.

This segues nicely into the governance issue at the IMF. Yes, China and other rapidly developing economies should be given a greater shareholding at the IMF to reflect their rising share of the world economy. But if they are going to use this to throw their weight around and block the IMF's professional advice, the world economy risks going from mess to bigger mess and catastrophe.