Global policymakers clashed over currency policies on Wednesday as Western leaders warned China and other emerging markets that widespread efforts to weaken exchange rates threatens to derail economic recovery.
U.S. Treasury Secretary Timothy Geithner said countries with large trade surpluses must let their currencies rise lest they trigger a devastating round of competitive devaluations.
"When large economies with undervalued exchange rates act to keep the currency from appreciating, that encourages other countries to do the same," Geithner said in a speech on Wednesday ahead of this weekend's semi-annual international Monetary Fund meeting.
Officials around the world fear such a "race to the bottom" may trigger trade tariffs and other measures that could damage global economic growth.
Using exchange rates "as a policy weapon" to undercut other economies and boost a country's own exporters "would represent a very serious risk to the global recovery," IMF Managing Director Dominique Strauss-Kahn was quoted as saying in Wednesday's edition of the Financial Times.
But China, which the West accuses of keeping the yuan artificially weak to promote exports, has rebuffed such calls. On Wednesday, Premier Wen Jiabao told the European Union to stop piling pressure on Beijing to revalue the yuan, saying a rapid exchange rate shift could unleash disastrous social turmoil in China.
""Many of our exporting companies would have to close down, migrant workers would have to return to their villages," Wen said during a visit to Brussels. "If China saw social and economic turbulence, then it would be a disaster for the world."
RACE TO THE BOTTOM
Low interest rates in Europe and Japan and expectation that the Federal Reserve will launch another round of money printing that could weaken the dollar have pushed currencies to the top of the agenda at the IMF meeting and at Friday's gathering of finance leaders from the Group of 20 economies.
Despite disagreement among governments, IMF chief economist Olivier Blanchard said he was "optimistic" about a solution. "We are just at the beginning of the process, so it's much too early to declare it a failure."
Others, however, are less sure.
Brendan Brown, economist at Mitsubishi UFJ Securities International, said the IMF, which has the United States as its biggest stakeholder, would not try to prevent further U.S. monetary easing or a weaker dollar.
"That Washington institution has failed in its central mission to prevent currency war," he wrote in a report.
The U.S. dollar tumbled to another 8-1/2-month low against major currencies Wednesday in anticipation of more Federal Reserve monetary easing, pushing the yen to a fresh 15-year high.
A strengthening yen prompted Japan to sell yen in currency markets last month, its first intervention since 2004, and several emerging market countries have followed suit or are threatening to.
Brazil fired the latest shot this week in what its finance minister dubbed an "international currency war," doubling a tax on foreign investors buying local bonds to 4.0 percent to curb its strong currency.
Some assigned blame to developed country policies, particularly the Fed's loose monetary policy, which has brought instability to exchange rates and forced countries such as Japan and Brazil to defend their exporters.
"It's doing nothing for the American economy, but it's causing chaos over the rest of the world. It's a very strange policy that they are pursuing," Nobel economics laureate Joseph Stiglitz said of U.S. policy.
Policymakers have highlighted the issue of global imbalances for years, with fundamental problems seen as the dollar's global dominance, China's overvalued yuan and Germany's lack of domestic consumption.
The IMF said Wednesday that emerging economies were set to grow nearly three times as fast than rich nations next year, with China the main engine of growth.
But emerging nations say the massive cash flows associated with this growth have damaged their exports, particularly as major economies try to restrain their own currencies' levels.
South Korea warned investors it might impose further limits on forward trading and India and Thailand said they were looking at steps to control speculative surges.
"It's natural in that context for them to say -- we can't just let our exchange rates appreciate and destroy our exports," Stiglitz told reporters at Columbia University on Tuesday.
Markets, however, think Fed easing is more likely than ever. That point of view was boosted by Chicago Fed President Charles Evans, who was quoted as saying the central bank should do much more to spur the economy.
And in a surprise move this week, Japan pulled interest rates on the yen back to zero and pledged to pump more funds into an economy struggling to compete with the currency near a 15-year high against the dollar. Brazil to defend their exporters.
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