The most overlooked cause of the economic weakness in the United States and Europe is what we call the "global currency wars." If all currency intervention were to cease, we estimate that the US trade deficit would fall by $150 billion to $300 billion, or 1 to 2 percent of gross domestic product. Between 1 million and 2 million jobs would be created. The euro area would gain by a lesser but still substantial amount. Countries that were engaged in intervention could offset the impact on their economies by expanding domestic demand.
China is by far the largest currency aggressor but has not been the major perpetrator of late. Three distinct groups are now involved. First are other Asian countries, including Japan, Singapore, Taiwan, Korea, Hong Kong, Thailand, and Malaysia. Second are major oil exporters including the United Arab Emirates, Russia, Norway, Saudi Arabia, Kuwait, and Algeria. Third are rich countries near to the euro area, most notably Switzerland but also Denmark and Israel. If Mitt Romney is elected US president, he will be able to label many countries as currency manipulators on his first day in the Oval Office, not just China, as he has promised.
These countries all exhibit rapidly growing levels of foreign currency reserves as well as significant current account surpluses. They buy US dollars and euros to suppress the value of their own currencies, keeping the price of their exports down and the cost of their imports up. Thus they subsidize exports and tax imports, enabling them to maintain or increase trade surpluses and pile up foreign exchange reserves. These tactics, in effect, export unemployment to the rest of the world. China has largely curtailed its currency aggression, at least for now, but many other countries remain highly active.
The currency wars started a decade ago and led to record trade imbalances. US and European policy makers tried to counter the effects and save jobs by encouraging a housing bubble. When the bubble popped, jobs disappeared. The US and Europe then adopted monetary and fiscal stimulus measures but prolonged financial deleveraging has offset much of their impact.
What can be done? The rules of both the International Monetary Fund and World Trade Organization forbid currency manipulation to maintain trade surpluses. These should be implemented at long last. Brazil has taken initiatives to this end and many other developing countries that run trade deficits, and lose from the currency wars, should join. The United States and the euro area should lead the effort. New bilateral and regional trade agreements, such as the Trans-Pacific Partnership, should include such rules.
If the preferred multilateral remedies continue to fail, revealing a huge gap in the international economic architecture, the aggrieved countries should act together to induce currency aggressors to mend their ways.
The most direct action would be countervailing currency intervention through which the US Federal Reserve and the European Central Bank buy foreign currencies to offset the exchange rate impact of others' aggression. Another option would be a surcharge on imports from currency aggressors, as adopted unilaterally by the United States in 1971. A third approach would be to impose a transactions tax or a withholding tax on US and European assets accumulated by the aggressors. Given the huge costs of currency aggression, such measures may become necessary to resolve this global systemic problem and allow recovery in the United States and Europe.
Read more: Op-ed: Time for a Fightback in the Currency War
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