Currency Wars

The unemployment rate in the USA has been hovering around 9% for the past 6 months. Despite the turnaround of many of the firms, there has been little change in the unemployment rates. Such high unemployment rates is not going to improve the consumer spending.
The key to recovery is to bring down the unemployment rates. It can be noted that despite the increase in liquidity in the U.S economy there has not been any significant improvement in the unemployment rates. The answers to this lies in China's growing current account surplus and the appreciation in currencies of the emerging economis.
China's growing current account surplus clearly highlights the fact that they have been the biggest beneficiaries of the increased liquidity in the global markets. The boom in the manufacturing sector has enabled China to take advantage of this excess liquidity. However it has to be noted that the exporters too have benefited due to the pegging of the Chinese currency. Analysts and Economists are of the view that the Chinese currency is undervalued by 20%-40%. The fixed currency regime is enabling the Chinese exporters to fight competition from other manufacturers throughout the world. US has been amongst the largest consumers on the Chinese products. This rise in demand for Chinese products is leading to fall in demand for the US manufactured goods and this in turn is one main reasons for rising unemployment in the U.S
US senate is currently considering imposing restrictions on Chinese imports but this issue will be in the back burner till the completion of the mid term election. Imposing restrictions on Chinese imports is not going to be a easy task considering the amount of US debt held by the China. Any restrictions on Chinese imports will also be countered by restrictions on US exports to China. Exports to China has been one of the main reasons for the turnaround of companies like GM and Ford. US treasury secretary Timothy Geithner has been very cautions during the recent G 20 summit. Upper limits for current account surplus for countries like China should enable the US to reduce its trade deficits but this move may not force China to stop pegging it's currency. Growing criticism from US may force China to appreciate its currency, but this appreciation may not factor in the real macro economic picture. It should be interesting to see how the US tackles this issue after the mid term elections. Republicans are expected to do well in this elections, it is going to be interesting to see how the right wingers in the US intend to tackle this problem.
The chairman of the Federal Reserve Ben Bernanke has expressed his interest to infuse more money into the system. These funds will be used to purchase more of the US treasury leading to the surge in liquidity. Increasing supply of dollars should lead to depreciation of dollar against most of the currencies. This surge in liquidity should further lead to the rise in the Emerging market equities and asset prices.
Depreciating Dollar has been a cause of concern for most of the emerging markets. Brazil recently has doubled the tobin tax on capital inflows, Thailand has recently reintroduced the withholding tax. These moves should curtail the currency appreciation of these countries to some extent. RBI has intervened in the currency markets to arrest the Rupee appreciation. However recently the finance minister has openly said that a country like India having a high current account deficit should refrain from imposing taxes on capital inflows. Shankar Acharya (Former advisor to the PM) in his column in business standard wrote that capital inflows should be taxed considering the fact that the inflows may rise after Fed's QE2 announcement causing the Rupee to further appreciate.
In the past many analysts were of the view that P-Notes were (partially) banned in 2007 mainly to bring down the capital inflows. This move did not go down well with the FII's. Similarly any moves to tax capital inflows may hamper the confidence of the FII's. Since we are a capital importing country we must not bring in any reforms that will hurt the confidence of the FII's.
Considering the above case it can be said that the finance ministry is taking the right step by not taking any actions against capital inflows. However appreciating Rupee is surely a cause of concern for exporters. Therefore RBI intervention is a must considering the fact that taxing capital inflows may not be positive for the country. Slowing down Rupee appreciations should enable exporters to compete with countries like Brazil and other emerging economies.
Looking at the recent events it can be said that G 20 has become very important in today's context. It should be interesting to see how the global economies intend to bring an end to the recent currency wars. Fed's bond purchase plan should help RBI determine it's role in the currency markets. To sum it up I would say that wars are now being fought using paper.