Competitive devaluation for economic growth

Competitive devaluation for economic growth Calvin M Sidjaya ;   A Research Associate at Royston Advisory Indonesia

JAKARTA POST, 17 November 2012

There are ongoing concerns that the Chinese currency, the yuan, has been intentionally undervalued and does not reflect the real power of the country’s economy. The yuan has gained 30 percent since 2005; however, Chinese trade partners believe it is not enough and urge China to end its currency control and let the yuan fluctuate in the market. China with approximately US$3 trillion in foreign reserves could transform the Chinese central bank into an institution with the biggest amount of money in modern history. It could finance the entire European Stability Mechanism amounting to ¤500 billion, save the troubled European countries and still retain half of its reserve. The Chinese central bank has enough in its arsenal to manipulate its currency. However, there is little room to negotiate due to excessive power of Chinese foreign reserve. The United States is still struggling to recover from its mortgage crisis. Japan is still plagued with the long-term deflation it suffered from in the 1990s. Europe will follow Japan due to excessive austerity measures that will diminish people’s purchasing power and pension benefits.  The three central banks of the US, Japan and Europe are out of options after imposing near-zero interest rates that have shown disappointing results. Theoretically, lowering interest rates will discourage people from saving money and boost the economy. However, with interest set at near-zero, there is not much room for monetary policy other than following China’s footsteps: currency manipulation. There have been long-time arguments that developing countries like China have stolen the manufacturing jobs in developed countries with their cheap currency. However, this is a paradox. Most developing countries adopt soft currency and developed countries have long benefited from this situation by relocating their industries to the Third World countries to reduce costs. The Federal Reserve, Bank of Japan and European Central Bank still have one last tool to unravel the manufacturing jobs and uncompetitive export problems: competitive devaluation. These three central banks are the most widely used currency in the world. They could virtually print money until it reached certain equilibrium. If the problem of export lies with the expensive import, due to developing countries’ cheap currency, then all the central bankers have to do is inject more liquidity into the market, which will devalue its currency. There are of course, new risks for developing countries such as sudden highly-liquid capital inflow.  Indonesia experienced this situation during 2009 and 2010 when the rupiah appreciated dramatically due to a massive influx of foreign funds. Exports became less competitive and import climbed up as a result. However, it also brought benefits such as reducing energy subsidy costs, slowing down imported inflation, restoring the rupiah’s value which it lost during 1997 and making the stock market bullish. The power of the cheap Chinese currency is unshakeable. It most likely will not seek a non-zero sum game. Indonesia constantly suffered import deficit with the Chinese due to the binding agreement of Chinese-ASEAN Free Trade Area, which came into force in 2010. The Trade Ministry has been trying to resolve this problem by opening trade agreements with non-traditional markets such as Africa and Latin America to help cushion the trade deficit. Bank Indonesia could not simply print more money to devalue currency for the sake of making exports more competitive. Indonesia is currently an oil net importer. Inflation and price stability are largely dictated by the international oil price, whose foundation is vulnerable to the rising energy prices. In contrast, developed countries have a more powerful arsenal to combat the China’s cheap currency. Injecting more liquidity and devaluing the currency competitively could be considered a plausible option if they need to revive manufacturing jobs and boost exports. The real challenge, of course, is whether the citizens could swallow this bitter pill. Developed countries have for a long time enjoyed their currency being overvalued. The real problem arises when the citizens must face the fact that the value of their currency is diminishing against other currencies, which causes them to pay more for the previously cheap imports. The recipe is economic, the impact is political. Devaluation is never a popular tool since it will diminish purchasing power and reduce life standard. There is also the problem that currency devaluation could quickly spiral out of control — as experienced by Germany during von Havenstein’s period as Bundesbank governor.  However, the monetary world has been largely different compared to the World War I era. Most countries trusted hard currency instead of their currency due to its status. Hard currencies will not lose the trust of the world even after being competitively devalued. Developed countries proportion blame on developing countries for stealing their jobs and hurting economic growth. A competitive devaluation of their own currency could be a possible solution to bridge the gap. Relocating the Third World jobs back to their country should even be considered to solve the employment problem. ●