Economic recovery at the expense of your neighbors? The wave of competitive currency devaluation further intensified in the month of January while pessimism grew that the year 2013 would be remembered as the year of a global exchange rates war. In many countries, quantitative easing and the ensuing currency depreciations are touted as the final prescription to boost exports and re-energize sagging domestic economies. Forget about the detrimental fallout for other countries. A blame game has already started: National leaders are pointing fingers at each other in Davos and elsewhere.
All things being equal, any artificial adjustment of exchange rates brings with it immediate export enhancement at the expense of export reduction by other countries. The beauty of this scheme is that, immediate impact on trade notwithstanding, trade rules hardly touch upon this issue. It is difficult to pinpoint a provision in a trade agreement that directly regulates a general financial policy such as an exchange rate scheme.
Stated differently, currency depreciation has three characteristics: One country gains, the other country loses that much. Should everyone employ this policy, the steam will build inside the pot without any vent-hole.
The only vent-hole, perhaps, is to respond in kind through similar retaliatory depreciation so as to cancel it out. This self-rescue attempt then sets off yet another retaliation by other countries. While a chicken and egg problem continues, more fuel is being poured on the fire. It is against this backdrop that big players like the United States, Japan, Germany, Brazil and China are digging their heels in. When advanced economies such as the United States, the EU and Japan employ currency depreciation to boost the domestic economy and exports, it would be just unrealistic to expect other countries to resist the temptation.
The high-strung tension concerning currency depreciation has made all countries keep a keen eye on their competitors’ intervention in the foreign exchange market. Even conventional intervention in the foreign exchange market for prudential regulation causes other countries to raise an eyebrow. Suspicion and mistrust are taking root.
Should we let this escalation spiral out of control, any hope for global economic recovery through good-faith multilateral cooperation ― including, most notably, the 2008 G20 covenant to refrain from adopting protectionist measures in the aftermath of economic crises ― will be effectively killed. The combination of frustration and retaliatory sentiments is a perfect recipe to have countries consider more direct ways to restrict importation believed to have been assisted by currency devaluation by other countries.
The pool of import restriction options at the border ― ranging from imposing extra duties to issuing import licensing ― is bottomless. A perfect environment for the monster of protectionism to raise its head again. Protectionism lives on suspicion and mistrust among countries, and the continuing exchange of pointed words among economic leaders shows us that there will be a plentiful supply of both for the time being.
At the moment, the voice of concern over the global race of currency depreciation is mainly about the loss of export volume ― in the case of Korea, one report expects a 30 percent decrease of Seoul’s exports this year if the current situation persists. Well, this is a serious concern for any country. But the more important threat facing us is what this recent development bodes for the global economic and trade regime ― protectionism is still alive and kicking.
The exchange rates war is about to unchain it. A loss of export volume would simply pale in comparison to the level of devastation to be caused by the resurrection of global protectionism.
A messy road is ahead of us in the year 2013 and pretending otherwise offers no help. Countries are calling each other evil-doers, so how do we restore trust?
By Lee Jae-min
Lee Jae-min is a professor of law at the School of Law, Hanyang University, in Seoul. Formerly he practiced law as an associate attorney with Willkie Farr & Gallagher LLP. ― Ed.