All eyes are on Canada this February and not just because the Vancouver Winter Olympics 2010 are about to kick off next week. Last week, finance moguls from the Group of Seven economies met in Ottawa to discuss the state and fate of the global economy. Among the trending topics was the ongoing debt crisis in the euro zone, which was then downplayed by ECB President Trichet. According to him, the Greek government should be able to make the necessary decisions to alleviate the situation.
On the global perspective, finance ministers seem to agree that although an economic recovery is underway, financial stability is not yet set in stone. In light of this situation, G7 leaders agreed to keep stimulus in place until financial and economic conditions improve significantly – not like we haven’t heard that one before!
Another issue that was brought up was the current state of exchanges rates. According to some, the current global imbalance in exchange rates is one of the factors preventing a full-fledged worldwide economic recovery.
Let me try to enlighten you, my young padawan readers. What we’re seeing right now is a growing imbalance between the trade surpluses of Asian countries and the rising deficits of their Western counterparts. These Asian countries have accumulated large surpluses which are helping spur growth. However, they have been able to do this because of by putting a tight rein on currency valuation. By keeping local currency relatively weak, they are able to stimulate demand for their exports and therefore giving them an advantage over other economies.
In order to fix this mess, the G7 nations believe that countries with inflexible exchange rates should allow their respective currencies to appreciate. But honestly now… Who do you think the G7 is referring to when they talk exchange rate flexibility? China, of course!
In order to stabilize China’s trade industry, its domestic currency, the Yuan, is pegged to the dollar, making it rise and fall with the dollar. This is done so that Chinese exports are affordable, no matter the state of the global economy. By allowing the Yuan and other Asian currencies to appreciate, the Western part of the world is given a little piece of the export pie as their goods are made more affordable. At the same time, this boosts domestic consumption in the East, making Asian countries less reliant on exports for growth.
It appears once again that the G7 nations, the US in particular, are trying to use their influence in the international arena to pressure countries like China to alter its currency policy. In a statement made by US Treasury Timothy Geithner just recently, some Chinese officials are reportedly starting to see the benefits of having a floating exchange rate policy. Geithner also said that this policy shift is “likely” to occur some time in the future.
With mounting pressure from other big economies, is it only a matter of time before China allows the Yuan to appreciate? If what Geithner is saying is true, then it’s not a question of if anymore but when. Now, if Big Brother China changes its ways, will its little Asian brothers and sisters follow suit? Short USD/CNY, anyone?