Keep the Faith: G-20 Can Stop Currency War

Alarmist concerns about impending currency wars were temporarily moderated by the G20 finance ministers’ pre-summit meeting in Gyeongju, where they agreed to work towards limits on the current account deficits and surpluses of their balance of payments.

But they flared up again with the launch of a new round of quantitative easing—QE2—by the US, triggering fears of dollar devaluation and floods of hot money into emerging markets. Is it peace or war now on the currency front? Is the Gyeongju “agreement” just another pious wish without practical implications? What does it mean for the G20 summit?

Sceptics will highlight that the agreement does not specify numerical ceilings. A symmetric upper bound of 4 or 5 per cent for deficits and surpluses was under consideration, but was dropped. The communiqué states that “national or regional circumstances” would be considered, highlighting the situation of commodity exporters, whose current accounts vary considerably with prices.

It was also agreed the International Monetary Fund would provide guidance on how to implement the agreement, but it is not clear how it will do this. It is unlikely anything more concrete can be agreed at this week’s summit, except perhaps more detail on indicators to determine current account limits, but no more. Some will therefore dismiss the agreement on targeting upper bounds for current accounts as inconsequential and argue the G20 is losing credibility as a “potential steering group” for the world economy.

In fact the agreement, if it is endorsed by the leaders, may constitute a significant step forward for international economic co-operation. First, it is right that the focus has shifted to “outcomes”, in the form of current account imbalances, and away from the exchange rates themselves. After all, if the Chinese surplus were to dwindle to a small amount, with China importing almost as much as it exported, while the Chinese exchange rate remained the same, the world would stop worrying about Chinese exchange rate policy.

Conversely, if, as has been the case for Japan in the past, a large surplus persisted, despite an exchange rate appreciation, the global deflationary impulse from the Chinese surplus would continue to pose a challenge.

Second, the proposed agreement is cast into a multilateral and symmetric framework, lessening the US-China tensions and rightly encompassing the problem of other significant imbalances, including notably the German and Japanese surpluses and the US deficit. Many emerging countries are also threatened by imbalances because of the recent surge of short-term capital inflows they are receiving, largely caused by low interest rates in advanced countries.

The new round of quantitative easing by the US Federal Reserve will amplify these capital flows to emerging markets, with some such as Brazil, South Africa, Turkey and India already facing not only currency appreciation but also widening current account deficits.

Third, the call for an increased role for the IMF can strengthen the necessary linkage between the G20 process and the more inclusive work of the IMF. Both the rich G7 countries that traditionally did not pay much attention to the IMF, and the emerging market countries always suspicious of the IMF’s encroachment on their sovereignty, are now calling for a greater role for the IMF to help implement the agreement to limit imbalances.

In that context, the IMF governance reforms likely to be endorsed in Seoul, shifting more than 6 per cent of quota shares to dynamic emerging economies and underrepresented countries by 2012, and two executive director chairs from the advanced European countries to emerging countries, will increase the legitimacy of IMF governance, although these are only partial steps in the right direction and they should be implemented more rapidly.

Finally, when evaluating the G20, it is important not to focus too much on the actual meetings and communiqués, and more on the process itself. In the past, the G7 meetings had led to close and repeated personal contacts between key economic policymakers and civil servants of the club of advanced countries. The familiarity and often personal trust that such repeated substantive interaction creates may not be visible, but is nonetheless very important to international co-operation, particularly at times of crisis. Indeed many G7 officials complain that the G20 has reduced the degree of informal familiarity that they used to enjoy. That is a small price to pay for now having the enlarged group of countries reflecting the world of the early 21st century around the table.

It may take some time, but the G20 process is likely to lead to much greater personal familiarity and a more common understanding of the key policy challenges for policy makers and their staff, which in turn can greatly contribute to tackling problems and co-operation. Indeed, it was the shuttle diplomacy of some senior civil servants of G20 countries that made the Gyeongju agreement possible and diffused tensions.

Behind the fanfare and excessive theatrics of the summits, a global network is growing that could become the backbone of international economic co-operation in this age of accelerating change and interdependence. We should give it a chance to work.