'Wake up to the dangers of a deepening crisis' and 'One of the most influential theories about exchange rates in the age of globalisation may be about to go up in smoke' shrieks the Financial Times. 'Of profound political importance' says Liam Halligan in the Telegraph.
The FT Article, by Wolfgang Munchau, discusses an increasingly commonly held belief. He traces world economic systems like geological strata. First we had the gold standard; then after the war we had Bretton Woods, the system under which all currencies were quoted against the dollar. Then we had Bretton Woods II which is what we have been living under without knowing it, and now that has come to an end.
In my view the theory, which to be fair Munchau doesn't much like, seems to have missed out a bit and exaggerated the recent bit. Bretton Woods established fixed exchange rates against the dollar which, to a diminishing degree, was backed by gold. After that we had floating exchange rates (which started for Britain back in Ted Heath's early years). And then we had globalisation.
What some refer to as Bretton Woods II is the system by which the Far Eastern economies, China, Japan and the smaller ones, sell goods to America in amazing quantity. What would normally happen under a system of floating exchange rates is that the Far Eastern currencies would then rise against the dollar. But that wouldn't suit China (we'll deal with Japan in a minute) because it would make its exports more expensive. So China manipulates the exchange rate, keeping the Yuan artifically low and their exports cheap; Chinese exporters can't hold dollars but have to sell them to the Bank of China at the artificial rate, and the BoC buys US Treasury Bills thus keeping the dollar relatively high and dollar interest rates relatively low so the American Consumer can buy more Chinese goods. So all Bretton Woods II is, then, is the failure of emerging economies to adapt to floating excvhange rates, and a large dollop of globalisation.
And now it is unravelling; the dollar is falling. But the dollar has been here before. In 1985 the problem was Japan. The US current account deficit was going through the roof, just like now, because Americans were buying Japanese goods, and the dollar had to fall to prevent severe recession. So the major powers, and Japan for the first time, got together and intervened in the currency markets to let the dollar fall. US exports rose, ironically to everywhere except Japan where they didn't like the idea of foreign goods. The people who suffered were the Europeans.
And this, in my view is what will happen again. Not currency intervention - the markets are too big for that, but an agreement between the US and China. Don't forget who suffers most if the US stops buying Chinese goods: the Chinese. Europe, with its export based economies and mature markets, think the euro is already strong enough against the dollar. I heard Airbus is unprofitable at $1.25; if it goes to $1.50????
Yes there will be a US recession, yes that will affect us, yes the falling dollar will affect us more. In the UK consumer spending might hold out, keeping our factories open. I am more pessimistic about Europe. If governments start holding the euro as their reserve currency it will make matters even worse. Unless something can be done we will import America's banking crisis, and we will import America's trade deficit. Europe will ask China to revalue the Yuan. But I have a feeling China is only interested in the USA.
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