Perils of the global monetary non-system
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Uncertainty seems to be the only certainty for the global economy after the 2008 financial crisis. While the period preceding the financial crisis is termed as the great moderation because of underlying stability and expansion of economic activity in various parts of the world, the phase after the crisis—which still continues—can perhaps be dubbed as of being one of continued chaos. The global economy has not been able to attain the desired level of economic growth and is dealing with one risk after another. Although policy intervention in the immediate aftermath of the crisis managed to contain the damage, it has proved insufficient in restoring the pre-crisis order. Consequently, the world is struggling continuously to cope with economic risks with political implications. Now, all of this has been further complicated by the focus of US President Donald Trump’s administration on currency.
Trump believes that the dollar is overvalued and large trading partners of the US such as China and Japan have kept their currency undervalued to remain competitive. He was recently reported as saying, “You look at what China’s doing, you look at what Japan has done over the years...they play the money market, they play the devaluation market and we sit there like a bunch of dummies.” Meanwhile, the head of National Trade Council, Peter Navarro told Financial Times that Germany is using the undervalued euro to exploit the US and its other trading partners in the European Union. The German administration has rejected the accusation. Writing in The Wall Street Journal last week, for instance, Germany’s deputy finance minister Jens Spahn said: “Germany and the US understood early on that economic competitiveness is central to successful integration into the world market and for reaping the benefits of globalization. Blaming a country that has embraced these tasks and benefits from a highly competitive business environment would be bizarre. Nobody can have an interest in provoking a trade war.”
The global financial situation has become fairly complicated. The problem for the US is that given its domestic economic condition, the dollar is likely to strengthen in the short to medium term; this will have a bearing on its trade balance. And it is true that Germany has the advantage of a weaker euro as its value depends on the fundamentals of the entire euro zone. But, to be fair, German policymakers have been vocal against the policies of the European Central Bank (ECB) which are adding to the weakness of the euro. Meanwhile, Japan is also pursuing aggressive quantitative easing with negative policy rates, which has implications for the currency market. However, China, which is often accused of keeping the currency undervalued and accumulating large reserves, is now busy intervening in the market to defend the renminbi. China has lost about $1 trillion in defending its currency against depreciation.
To be sure, these complications in the global currency markets are not new. The then Brazilian finance minister, Guido Mantega, talked about an “international currency war” in 2010 to reason that countries are using competitive devaluation to improve their export competitiveness. The former governor of the Reserve Bank of India, Raghuram Rajan, raised the issue of spillovers from unconventional monetary policy on other countries on several occasions. For example, in a 2014 column, Rajan noted: “…the disregard for spillovers could put the global economy on a dangerous path of unconventional monetary tit for tat. To ensure stable and sustainable economic growth, world leaders must re-examine the international rules of the monetary game, with advanced and emerging economies alike adopting more mutually beneficial monetary policies.”
The unconventional monetary policy being followed by the ECB and the Bank of Japan is an extension of the policy adopted by the US Federal Reserve after the financial crisis. In fact, it is still not clear as to how and when the Federal Reserve will start shrinking its balance sheet which has expanded from the level of about $900 billion before the financial crisis to the present level of about $4.5 trillion.
Thus, the unconventional monetary policy continues to remain a risk for the global financial system as the extent to which systemically important central banks will use it and the manner of their exit are still not clear. The unpredictable style of functioning of the new administration in the US and its protectionist policies has further increased the level of uncertainty for the global economy. The hope of coordination on issues like the competitive use of currency and its impact on trade has also diminished because of the unilateral actions of the Trump administration.
In the last few years, India has managed the risk emanating from currency and financial market well; it will now have to be vigilant to be able to protect its trade interests.
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