Column : Beggar thy currency or thy self?

In today's world, no significant group of countries is looking for currency strength. Some resist appreciation actively and openly; others do so in a less visible manner. Only the eurozone seems to accept being on the receiving end of other countries' actions.

None of this is unprecedented, and there is a lot of scholarship demonstrating why such beggar-thy-neighbour approaches result in bad collective outcomes. Indeed, multilateral agreements are in place to minimise this risk, including at the International Monetary Fund and the World Trade Organisation.

Yet, when push comes to shove, country after country is being dragged into abetting a potentially harmful outcome for the global economy as a whole. Worse, this process has not yet registered seriously on the multilateral policy agenda.

There are many reasons for this, ranging from the rather debilitated state of multilateral governance to the urgency of domestic issues currently commanding national policymakers' attention. But there is also something else at work: The causes of today's predicament are difficult to comprehend and counter effectively.

Unlike the old days, the threat of currency wars is not directly related to trade imbalances and balance-of-payments crises. Rather, an important driver is major central banks' pursuit of experimental measures in order to compensate for policy inadequacies and political dysfunction elsewhere.

If the world is to avoid serious harm, it is important to understand the dynamics at work. A simplified description runs as follows: Facing low growth and high unemployment, and with other policymakers stuck on the sideline, a central bank like the US Federal Reserve feels that it has no choice but to adopt a highly accommodating monetary policy.

As policy interest rates are already floored at zero, it is compelled to venture ever deeper into the uncharted realm of "unconventional policies".

The aim, as Fed Chairman Ben Bernanke said again in December, is to "push" investors to take more risk. Specifically, it is hoped that an artificial surge in asset prices will make people feel richer and more optimistic, thus triggering "wealth effects" and "animal spirits" that stimulate consumption and investment spending, bolster job creation, and, in the process, "validate" the artificial asset pricing.

... contd.

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