The solution is to expand demand, but with surplus countries doing more than the deficit countries

TO BE NOTED: From the FT:

"Currency squabbles are set to worsen

Published: April 10 2009 19:05 | Last updated: April 10 2009 19:05

As in the 1930s, complaints about “beggar-thy-neighbour” trade and exchange rate policies pollute the global atmosphere: eurozone member countries complain about the falling British pound; Americans complain about China’s “manipulation” of the renminbi; deficit countries complain about excess supply in surplus countries; and surplus countries complain about protectionism in deficit countries.

So who is right? Everybody and nobody. We are hearing the results of a mutually destructive struggle over slices of the dwindling global demand cake. That way lies competitive devaluations and trade wars. The solution is to expand demand, but with surplus countries doing more than the deficit countries.

In the fourth quarter of 2008, nominal gross domestic product shrank at an annualised rate of 4 per cent in the UK, 4.2 per cent in the eurozone, 4.6 per cent in Germany, 5.8 per cent in the US and 6.4 per cent in Japan. This, then, is a world of grossly deficient demand.

This is also a world of huge current account surpluses and deficits. From the point of view of countries in deficit, surplus countries are stealing “their” domestic demand. But countries with strong currencies regard devaluation by others as cheating, since it hurts the exports on which they depend so much.

The eurozone’s concern about sterling’s slide is understandable. But it is unreasonable. Sterling is a floating currency that fell sharply at the end of last year, when it became evident how badly the UK’s financial sector and economy would be hit by the crisis. Since UK domestic demand is weak and last year’s trade deficit was 6.5 per cent of GDP, a depreciation is what any economic doctor would order. A rise in net exports is essential for sustained recovery. It is not the UK’s fault that eurozone member countries in the same plight chose to tie themselves to the euro mast.

More objectionable would be attempts by countries with large trade surpluses to protect themselves against adjustment by over-indebted deficit countries. Yet the currencies of a number of countries with robust external positions have had large real devaluations since the crisis became severe early last autumn. On the list are several east Asian countries, though not China.

More fundamentally, complaints about beggar-thy-neighbour policies are inevitable so long as the world economy suffers from deficient demand. The solution is to pursue fiscal, monetary and, where necessary, structural policies likely to promote expanded demand in the medium term. But surplus countries need to understand that it is they who are in a better position to expand demand safely, not those with the large structural deficits.

The alternative to currency conflict and trade war is demand expansion. Complaining about the bitter fruit of refusals to understand this is as absurd as it is pointless."