The G-20: Sound and Fury Signify Something in Seoul

On the eve of an economic summit meeting of the G-20 world leaders in Seoul, South Korea, disturbing signs of discord are emerging over currency valuations and trade between the U.S. and its major trading partners. Failure to achieve an agreement could set off more "currency wars," in which nations try to drive down their currency's value to achieve an edge in global trading.

China gave contradictory indications of its stance on Nov. 9, lashing out at the U.S. for the Federal Reserve's policy of buying $600 billion in bonds to boost the economy. But it also raised the exchange rate of the yuan, its national currency, by the biggest amount since 2005 in an apparent effort to avoid a confrontation with the U.S. and European leaders on Nov. 11-12 in Seoul.

Germany, one of America's closest allies, has now emerged as its biggest critic on economic policy. German Chancellor Angela Merkel dismissed a U.S. proposal to set maximum targets for trade surpluses, which had been agreed to at a meeting of finance ministers in late October, but has now been abandoned by U.S. Treasury Secretary Timothy Geithner. Germany has one of the biggest trade surpluses in the world economy.

"Clueless"

"I don't think much of quantified balance of payments targets," Merkel told the Financial Times, warning that the world economy faces a danger of protectionism, a clear reference to efforts in the U.S. Congress to curtail imported goods.

Only a day earlier, German Finance Minister Wolfgang Schaeuble had criticized the American economic policy as "clueless." "It doesn't add up when the Americans accuse the Chinese of currency manipulation and then, with the help of their central bank's printing presses, artificially lower the value of the dollar," Schaeuble told Der Spiegel magazine.

That caustic attack suggests that no deal has been reached in advance of the Seoul summit.

China and a number of emerging-market countries, such as Brazil, have accused the U.S. of undermining their currencies via the bond purchases known as quantitative easing. Those purchases have driven down the value of the dollar, which means emerging-market currencies are shooting up in value. That makes their exports less competitive and attracts "hot money" investments into their economies, which can cause inflation.

China and Taiwan imposed new capital controls on Nov. 9 in an effort keep the hot money out, joining Brazil, which last week raised taxes on foreign investments as a way of discouraging foreign capital inflows.

"Emerging economies are seeing large capital inflows and face mounting inflationary risks," says Chinese Vice Premier Wang Qishan. "There is excessive liquidity in the world and fluctuations in international financial markets. All of these are dampening market confidence."

Common Approach Now, Details Later

Geithner, who had been sure his proposal on limiting budget surpluses to 4% would be accepted at the G20, had to make a face-saving retreat. He told reporters in Tokyo that the U.S. won't use the dollar as a trade weapon and that he still supports a strong U.S. currency, despite evidence that the Fed move undercut the greenback's value in an effort to boost American manufacturing exports.

"We will never use our currency as a tool to gain competitive advantage," Geithner said. He added that he thought the leaders gathered in Seoul on Thursday would simply agree to work toward a common approach and leave details to their finance ministers to work out later.

China seemed to be hedging its bets before the meeting by allowing the yuan to rise 0.51% in a single day of trading. That was the largest advance since China dropped its explicit peg against the dollar in 2005. Beijing has been widely criticized, not only in the U.S. but around the world, for keeping its currency artificially low. That has damaged its trade balance with the U.S. and Europe, and also with other Asian countries, such as Thailand, that having floating currencies.

Gold? No. Capital Controls? Yes

One proposal to deal with the current currency crisis came from World Bank President Robert Zoellick, who suggested in an op-ed piece in the Financial Times this week that the G20 should consider using gold "as an international reference point of market expectations about inflation, deflation and future currency values."

But that suggestion flopped, with European Central Bank President Jean-Claude Trichet rejecting the idea as outdated, and several economists pointing out that the gold standard was one of the main causes of the 1930s' Depression.

A more likely solution came from another World Bank official, Sri Mulyani Indrawati, who said Asian countries might have to adopt capital controls to counteract quantitative easing's likelihood of causing asset bubbles to rise in developing countries.

"Certain assets will become, potentially bubbles," Sri Mulyani told Bloomberg news. "The quantitative easing will create a lot of liquidity flooding to the East Asia Pacific region, because it is the most dynamic and attractive with a higher return on investment."

Rate Hikes Aimed at Bubbles

China also took more efforts aimed at curbing currency inflows, requiring banks to hold more dollars and tightening controls of foreign equity investments in China as well as on Chinese overseas special-purpose vehicles.

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Analysts have pointed out that real estate in China, Hong Kong and Australia has already reached the bubble stage, with other assets likely to follow. China has raised interest rates in an effort to ease the real estate bubble, and more interest rate increases may soon be forthcoming.

The lack of agreement ahead of the G20 suggests that individual nations will be forced to take more action to insulate their economies from the effects of inflation, which the Fed's bond-buying program may touch off.

After last week's Republican victory at the U.S. polls, President Obama made clear that he'll do everything he can to support job creation in the U.S., including measures to boost exports. He has called for exports to double in the next five years, something that will be possible only if the dollar declines sharply against other currencies.