Beggaring the world economy

COMMENT
By RAGHURAM RAJAN

GLOBAL capital is on the move. As ultra-low interest rates in industrial countries send capital around the world searching for higher yields, a number of emerging market central banks are intervening heavily, buying foreign capital inflows and re-exporting them to keep their currencies from appreciating.

Others have been imposing capital controls of one stripe or another. In recent weeks, Japan became the first large industrial economy to intervene directly in currency markets.

Why does no one want capital inflows? Which intervention policies are legitimate, and which are not? And where will all this intervention end if it continues unabated?

The portion of capital inflows that is not re-exported represents net capital inflows. This finances domestic spending on foreign goods.

So, one reason countries do not like capital inflows is that it means more domestic demand “leaks” outside. Because capital inflows often cause the domestic exchange rate to appreciate, they encourage further spending on foreign goods as domestic producers become uncompetitive.

Another reason is that some of it might be “hot” (or dumb) money, eager to come in when foreign interest rates are low and local asset prices are rising, and quick to leave at the first sign of trouble or when opportunities back home beckon.

Volatile capital flows induce volatility in the recipient economy, making booms and busts more pronounced than they would otherwise be. But, as the saying goes, it takes two hands to clap.

If countries could maintain discipline and limit spending by their households, firms or governments, foreign capital would not be needed, and could be re-exported easily without much effect on the recipient economy.

Countries can overspend for a variety of reasons. The stereotypical Latin American economies of yesteryear used to get into trouble through populist government spending, while the East Asian economies ran into difficulty because of excessive long-term investment.

In the United States, in the run up to the current crisis, easy credit – especially for housing – induced households to spend too much, while in Greece, the government borrowed its way into trouble.

Unfortunately, though, so long as some countries like China, Germany, Japan, and the oil exporters pump surplus goods into the world economy, not all countries can trim their spending to stay within their means. Since the world does not export to Mars, some countries have to absorb these goods, and accept the capital inflows that finance their consumption.

In the medium term, over-spenders should trim their outlays and habitual exporters should increase theirs. In the short run, though, the world is engaged in a gigantic game of passing the parcel, with no country wanting to take the habitual exporters’ goods and their capital surpluses.

This is what makes today’s beggar-thy-neighbour policies so destructive: though some countries will eventually have to absorb the surpluses and capital, each country is trying to avoid them.

So which policy interventions are legitimate? Any policy of intervening in the exchange rate, or imposing import tariffs or capital controls, tends to force other countries to make greater adjustments. China’s exchange rate intervention probably hurts a number of other emerging market exporters that do not intervene as much and are less competitive as a result.

But industrial countries, too, intervene substantially in markets. For example, while US monetary policy intervention (yes, monetary policy is also intervention) has done little to boost domestic demand, it has spurred domestic capital to search for yield around the world.

The US dollar would fall substantially – encouraging greater exports – were it not for the fact that foreign central banks are pushing much of that capital right back by buying US government securities.

All this creates distortions that delay adjustment – exchange rates are too low in emerging markets, slowing their move away from exports, while the ease with which the US government is being financed creates little incentive for US politicians to reduce spending over the medium term.

Rather than intervening to obtain a short-term increase in their share of slow-growing global demand, it makes sense for countries to make their economies more balanced and efficient over the medium term.

That will allow them to contribute in a sustainable way to increasing global demand. China, for example, must move more income to households and away from its firms, so that private consumption can increase.

The United States must improve the education and skills of significant parts of its labour force so that they can produce more of the high-quality knowledge and service-sector exports in which the United States specialises. Higher incomes would boost US savings, reducing households’ dependence on debt, even as they maintained consumption levels.

Unfortunately, all this will take time, and citizens impatient for jobs and growth are pressing their politicians. Countries around the world are embracing shortsighted policies that cater to the immediate needs of domestic constituencies.

There are exceptions. India, for example, has eschewed currency intervention thus far, even while opening up to long-term rupee debt inflows, in an attempt to finance much-needed infrastructure projects.

India’s willingness to spend when everyone else is attempting to sell and save entails risks that need to be carefully managed. But India’s example also provides a glimpse of what the world could achieve collectively.

After all, beggar-thy-neighbour policies will succeed only in making us all beggars. — © Project Syndicate

Raghuram Rajan, a former chief economist of the IMF, is professor of finance at the Booth School of Business, University of Chicago, and author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.

Currency wars at a time of deficient demand

WHAT ARE WE TO DO
By TAN SRI LIN SEE-YAN

LAST week, Brazil’s finance minister said: “We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.”

This says it all. The International Monetary Fund has since warned of widespread currency interventions which could derail the fragile recovery. Many nations are engaged in policies to weaken their currencies. Further competitive devaluation will inflame global tensions.

At a time of continuing deficient demand, this is not the time for the world’s major currencies to face off in what can only be described as an “ugly contest”.

By the third quarter of this year (Q3), attention had shifted from the deep woes engaging the eurozone to re-emerging economic and fiscal fissures in the United States.

This sudden re-orientation of focus helped the euro reverse most of its springtime collapse, and saw the US dollar lose more lustre.

Then there is the ever-strong yen. Japan is faced with a deep economic malaise and is anxious to ease exporters’ burden. It is not surprising that Q3 highlighted the standoff over which of the three most actively traded currencies has the lousiest outlook.

The euro hit a new low against the US dollar (1.1917) on June 7 and for the first half of 2010, it was 15% from where it started the year.

But the euro rose 11.5% in Q3. Against the yen, the US dollar fell to a 15-year low (83.10 yen) in mid-September. That prompted the unleashing of a US$20bil blitz of yen selling, driving it off its high.

The yen has since returned to its pre-intervention rate. The end result: the US dollar not only slid against the euro and the yen, but also fared worse against most emerging market currencies.

When measured against a basket of major currencies, the US dollar sank to its lowest level since January. By Oct 5, the ICE Dollar Index was below 78, against 88 in June.

The grass gets crumpled

This is not the first time we see a currency conflict. In August 1971, the “Nixon shock” ended US dollar convertibility to gold. In September 1985, the Plaza Accord devalued the US dollar, notably against the yen. This time around, the target is the Chinese yuan.

The East has a saying – when tigers fight or make love, the grass gets crumpled. The United States has pressed hard on China to revalue faster; the European Union (EU) and Australia have since raised the volume of their rhetoric on China. Meanwhile, others have been intervening to hold their currencies down.

Australia warned Europe against reviving protectionism masquerading as environmentalism. The situation can only get worse. Already, the Institute of International Finance (IIF), representing 420 leading financial institutions, just revised upwards its latest forecast for net inflows of capital into emerging markets, showing a sharp increase to US$825bil for 2010. All in search of higher yields, thereby risking instability.

Of course, the United States and EU blames all this on China. But many emerging economies blame ultra-low interest rates in rich countries (reflecting aggressive quantitative easing, or QE) for diverting vast amounts of cheap funds to their domestic markets, creating a policy dilemma for most.

Their economies are growing nicely in the face of rising inflation. This limits the use of interest rates to curb these funds inflow.

On Oct 4, Brazil doubled a tax on foreigners’ purchases of local bonds. Australia and Indonesia kept their benchmark rates unchanged to ward off further inflows. The Philippines is expected to hold their rates. India and Thailand are considering new steps of protection.

The big problem remains. Globally, ad hoc currency interventions don’t work. At its heart is the US dollar, trapped in a downward spiral as expectations of further monetary easing by the Federal Reserve Bank (Fed) drags it lower.

The global architecture is broken. But how best to move away from a system where the US dollar plays the role of a major reserve currency and the United States sets global interest rates?

It looks like the entire Asian sovereign community is suddenly buying euro and yen – so much so the Japanese on Oct 6 lowered the target for its key overnight rate to 0.0% and 0.1%.

John Connally (Nixon’s Treasury Secretary) says it best when he famously told Europeans that the “US dollar is our currency, but your problem.”

In the absence of currency adjustments, the Chinese response appears to be, in the words of Financial Times’ Martin Wolf: “In effect, the United States is seeking to inflate China and China, to deflate the United States.” It’s a stalemate. The grass continues to get crumpled.

There is now, according to the IIF, “an environment of unilateralism and bilateralism laced with isolation and parochialism.” Somewhat exaggerated, but in essence, correct as I see it.

The yuan scapegoat

Reality check: The developed world suffers from chronic deficient demand. The IMF just cut its growth forecast. The six biggest high-income nations’ gross domestic product (GDP) in Q2 is nowhere near what it was in Q1 of 2008.

They are operating up to 10% below potential. In the United States and eurozone, core inflation is only 1%. Deflation beckons.

Those with trade deficits and surpluses alike all love to have export-led growth. In a zero-sum world, this can only happen if emerging nations shift to run huge current deficits. That’s not about to happen.

Also, the vast accumulation of foreign reserves complicates any meaningful adjustment. Between January 1999 and May 2010, reserves went up by US$6.8 trillion to reach US$8.4 trillion. China accounted for 30% of the world total, or equivalent to 50% of its own GDP. That’s the big picture.

Until the early 1970s, currency rates were fixed under the Bretton Woods monetary system. It fell apart with the US-inspired inflation of the 1970s. So the world moved to floating rates.

But most nations still chose to peg to the US dollar. With the euro, most of Europe moved to fixed exchange rates. Pegging offered the benefits of exchange rate stability, eliminating a source of uncertainty for investment and trade to flourish.

One catch though: pegged nations give up monetary independence. In the US dollar-bloc, they yield to the Fed and in the euro-bloc, the European Central Bank (ECB).

This is what China did when its yuan was pegged to the US dollar. In exchange for the benefits of exchange rate stability, it subcontracted much of its monetary discretion to the Fed.

For more than a decade, this served the world economy well; Americans raised their living standards and millions of Chinese enjoyed prosperity.

For years, the United States had pressed the yuan to revalue in the name of reducing the US trade deficit. What’s not so obvious is that much of this deficit is intra-company trade, that is, US firms outsourcing production to China to stay globally competitive.

Beijing bent for a while in the middle of last decade and adopted a crawling peg, allowing the yuan to revalue by 18% with little impact on US trade deficit. China re-pegged amid the financial panic in 2008. American clamour to revalue revived and the yuan relented and moved to greater “flexibility” last June. Recently, the yuan reached its strongest since 1993 – up 2% to 6.69 per US dollar but fell 10% against the euro. That’s far too slow for the United States and Europeans.

The US trade deficit with China surged to US$268bil in 2008, up from US$202bil in 2005. Currency is but one factor influencing where firms manufacture.

Furthermore, the United States no longer make many of the goods China exports. So a shift in business out of China would more likely mean relocation to other low-cost Asian nations, rather than rebuild US capacity.

The yuan has appreciated 55% against the dollar since 1994, when Beijing begun to overhaul its forex system. That bilateral imbalance is structural. As I see it, the only way the United States can fight off Chinese competitive challenges is to innovate and boost productivity at home.

Both the United States and EU now urge China to allow “an orderly, significant and broad-based appreciation” of the yuan. I think China is right to resist these calls, not least because a large revaluation is likely to damage China’s growth and basic restructuring plans.

China’s continuing expansionary “train” is pulling along growth in East Asia nicely, and to a lesser extent, that of the developed world as well.

“The world has already become partially de-coupled” says Nobel laureate Joseph Stigliz. China has learned from past experience, including that of Japan, which bowed to similar US pressures in the 1980s and 1990s, revaluing the yen from 360 per US dollar to a high 80 in 1995.

According to Stanford’s Prof R. McKinnon, one result was domestic deflation and its lost decades in growth. Meanwhile, Japan continues to run a trade surplus as imports fell with slower growth and cross-border prices adjusted. China helped lead the world out of recession and the world needs that to continue.

What’s China to do?

The media wants us to believe the biggest sinner in this game of beggar-thy-neighbour is China. But, in their own way, the United States, Britain and EU are engaged in much the same thing.

Massive QE has effectively created negative interest rates and debauched their currencies to boot with floods of liquidity. QE proved a highly effective way to devalue the dollar.

Indeed, it is a much more powerful form of persuasion than the threat of tariffs. The very prospect of more QE can rattle China and most of Asia to submission.

But the global imbalances that created the crisis have yet to be addressed by centring criticism on China. Reform of the international monetary architecture is needed to resolve the problem, with a global “clearing” organisation acting independently among nations to manage “surpluses” and “deficits”. This institution is intended to keep the world in balance. This won’t happen.

Maybe, the approach is wrong. I think the real problem is not the yuan’s exchange rate but its inconvertibility and capital controls. As a result, the yuan’s development has been stunted since private markets can’t recycle the flow of dollars arising from continuing large surpluses.

China’s huge reserves represent a significant misallocation of global resources. Instead of letting these reserves find their optimum private investment use, China uses them to buy US Treasuries and bonds.

Once made convertible, capital and trade flows will adjust through private markets rather than the Peoples’ Bank. That’s how Germany recycles its surpluses. In this way, a one-time modest revaluation accompanied by convertibility can assist in the global adjustment process, while avoiding the perils of Japan-like deflation.

Whether China is ready for convertibility of its yuan is a key question. All I can say is that stage-by-stage convertibility increases domestic pressures for China to further liberalise to develop its financial system, which in turn, helps in global rebalancing.

What’s important is for China and the other surplus nations (Germany and Japan) to understand that their policies are not helping the United States to rebalance.

Similarly, the United States and EU need to understand that the surplus nations simply can’t adjust fast enough to suit them.

Resolution requires realistic “grown-up” behaviour on the part of core parties in this dispute to agree to global rebalancing with care and with determination.

For a start, I see merit in the IIF’s call for a new coordinated currency pact by the core parties to hammer out with haste, an understanding to help rebalance the global economy.

It needs a more sophisticated version of the Plaza Accord to include “stronger commitments to medium-term fiscal stringency in the United States and structural reform in Europe.” The world deserves more, not less.

Former banker Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time teaching and promoting the public interest. Feedback is most welcome at
starbiz@thestar.com.my.

Buffett : US Wall St like a Church with Raffles

Buffett Compares Wall Street to Church With Raffle  

By Andrew Frye and Natalie Doss 

Warren Buffett, chairman of Berkshire Hathaway Inc. Photographer: Nelson Ching/Bloomberg 

"You should go broke. And I think your wife should go broke, too" Buffett says of CEOs whose firms require bailouts - AFP

Use of derivatives 'makes mockery' of federal rules, he says. 

Warren Buffett, the billionaire chairman of Berkshire Hathaway Inc., said Wall Street is like a church that benefits society, then falters by operating a gambling venture on the side.

Wall Street “does a lot of good things and then it has this casino,” Buffett, 80, said today at Fortune magazine’s Most Powerful Women conference in Washington. “It’s like a church that’s running raffles on the weekend.”

Buffett relies on investment banks to help finance acquisitions such as his $27 billion purchase of railroad Burlington Northern Santa Fe and to offer derivative contracts that allow him to speculate on stock markets. Omaha, Nebraska- based Berkshire invested $5 billion in Goldman Sachs Group Inc. in 2008 at the depths of the credit crisis. Buffett has also faulted Wall Street for excessive bets on U.S. housing.

“People have a propensity to gamble, and it gets made easier and easier for them,” Buffett said. “One of the problems we still have is we have unbalanced incentives for managers of huge financial institutions.”

Buffett has called for greater accountability from bank executives whose risk-taking produces losses for shareholders and imperils the economy. The use of derivatives has allowed banks to add risk and “makes a mockery” of federal rules designed to limit losses, Buffett said. “You should go broke,” he said of chief executive officers whose firms require government bailouts to protect society.

‘Your Wife Should Go Broke’
“And I think your wife should go broke, too,” he said. 

Berkshire, where Buffett serves as CEO, weathered the financial crisis without taking a capital injection from the U.S. government. Some of Berkshire’s biggest investment holdings took bailouts, including Goldman Sachs, the most profitable Wall Street firm, which got $10 billion in taxpayer funds. Wells Fargo & Co., which counts Berkshire as its biggest investor, got $25 billion.

Buffett reiterated praise for financial-company bailouts, and said government’s treatment of shareholders won’t create a so-called moral hazard in the equities market. Stockholders of companies including insurer American International Group Inc. and Citigroup Inc. lost at least 90 percent of their investments, Buffett said.

“The common shareholders did not get bailed out of those institutions, they lost hundreds and hundreds and hundreds of billions,” Buffett said. “There is no moral hazard in terms of big financial company stockholders.”

Goldman Sachs

Goldman Sachs and San Francisco-based Wells Fargo repaid their U.S. rescues.

Buffett built an equity portfolio of about $55 billion by buying and holding stocks of companies that he believes have durable competitive advantages. Berkshire is the largest investor in Coca-Cola Co. and American Express Co.
 
His investment in Goldman Sachs came with warrants that enable him to buy $5 billion of the company’s stock at $115 a share, compared with yesterday’s closing price of $146.57. Exercising the option at that price would generate a profit of more than $1.3 billion.

Buffett’s pronouncements on markets and on the economy are watched by policy makers and investors. Buffett, the world’s third-richest person, oversees more than 200,000 employees at Berkshire and the company’s more than 70 subsidiaries. At the conference today, he said his businesses are “coming back” after the recession. When asked for his outlook on equity and fixed-income markets, Buffett said investors buying bonds after yields fell this year “are making a mistake.”

‘Stocks are Cheaper’

“It’s quite clear that stocks are cheaper than bonds,” Buffett said. “I can’t imagine anyone having bonds in their portfolio when they can own equities.”

Buffett said wealthy individuals should pay higher taxes. The billionaire, who said he probably pays a lower tax rate “than the cleaning lady,” criticized cuts made under former President George W. Bush. President Barack Obama, whom Buffett advised during his election campaign, is seeking lawmaker support to phase out breaks for families making more than $250,000.

“I have no tax shelters, I have no tax accountant, my tax shelter really was the Bush administration,” Buffett said. “They took care of me. They thought here’s this endangered species, kind of like the bald eagle out in Omaha, and if we don’t take care of this guy they’ll all quit working and we won’t have any arbitrageurs or hedge fund operators. So we’ve gotta give this guy a special kind of break.”

Lawmakers are considering measures to raise revenue under the shadow of a U.S. deficit previously forecast by the White House budget office to be a record $1.47 trillion for 2010 and $1.42 trillion for fiscal 2011, which started Oct. 1.

“If you’re not going to get it from guys like me, why should we get it from the people who served us lunch today,” Buffett said.

To contact the reporters on this story: Andrew Frye in New York at afrye@bloomberg.net; Natalie Doss in New York at ndoss@bloomberg.net.
To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net.

Currency wars 'hurt global markets', World leaders seek currency peace,China yuan reform

Currency wars 'hurt global markets'

International Monetary Fund and European Union warn nations  against undervaluing their currencies.

Dominique Strauss-Kahn, IMF Managing Director, says re-balancing currencies should be the main goal [AFP]  Global policymakers clashed over currency policies as Western leaders warned China and other emerging markets that widespread efforts to weaken exchange rates threaten to derail economic recovery. Officials around the world fear that a rush to undervalue currencies 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," Dominique Strauss-Kahn, the International Monetary Fund (IMF) director, said ahead of Friday's twice-yearly IMF meeting. European officials said on Thursday that a rapidly rising euro, victimised by an undervalued US dollar and Chinese yuan, could threaten eurozone recovery and vowed to press both Washington and Beijing to take action. European Union leaders contend that the euro - currently at an eight-month high of more than $1.40 - is being squeezed in a  transglobal race for trading income. "The euro is currently bearing a disproportionate burden in the adjustment of the global exchange rate," a spokesman for Olli Rehn, the European Union Economic Affairs Commissioner, said. "This may affect recovery of the European economy," the spokesman stressed, reiterating that the yuan is "still significantly undervalued." 'Singled out' But China, which the West accuses of keeping the yuan artificially weak to promote exports, has rebuffed the criticism. Al Jazeera's Melissa Chan, reporting from the Chinese capital of Beijing, said that while China is typically "singled out" as a currency manipulator, within the country, there is an understanding that its economy must move "from an export-driven model to a consumer-based one". "But while everyone knows that China has a trade surplus with the United States, few know that China has a trade deficit with countries like Brazil, South Korea and Japan." 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." EU Commissioner Rehn's spokesman also contended that US currency policies were also troubling the European Union and said the EU would raise the same complaints it did with China on Wednesday "to the Americans, to Geithner too". Competitive devaluations However, Timothy Geithner, the US treasury secretary, continued his attacks on countries with large trade surpluses, saying they 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 on Wednesday, in remarks that appeared aimed at China. Some economists suspect that it suits the United States to have a weak dollar and a strong euro when the pace of recovery is so dependent on winning the competition for exports with emerging powers such as China, India, Russia or Brazil. 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. Al Jazeera's Steve Chao, reporting from Tokyo, Japan, said that while the Yen is seen as a stable investment, "hordes of speculators" have switch to the currency, driving its value up. This, he said, lead to a "rebellion of sorts" as the government had to take unilateral action in manipulating its currency. "And there lies the vulnerability. Facing major pressure from Japan's own industries, the Bank of Japan slashed interest rates to zero, and sold off a trillion yen," our correspondent said. "That marks the largest one-day currency action ever in this country." Newscribe : get free news in real time  World finance leaders seek currency peace International Monetary Fund (IMF) Managing Director Dominique Strauss-Kahn (R) and World Bank President Robert Zoellick chat at the beginning of G-24 ministers meeting during the annual IMF-World Bank meeting in Washington October 7, 2010. Credit: Reuters/Yuri Gripas By Emily Kaiser WASHINGTON | Fri Oct 8, 2010 12:27am EDT WASHINGTON (Reuters) - World finance leaders on Friday will try to soothe simmering currency tensions which threaten to drag on an economic recovery that is already too slow and uneven for their liking. The Group of 20 finance ministers scheduled a working breakfast on the sidelines of this weekend's International Monetary Fund and World Bank twice-yearly meetings. The smaller G7 grouping of advanced economies holds a closed-door dinner later on Friday. Neither group is expected to issue a formal statement, but G20 officials said foreign exchange matters will be discussed at both events amid concerns that countries will intentionally weaken their currencies to pursue export-led growth. China, usually at the center of the currency debate, has company this time. Officials are still leaning on Beijing to allow the yuan to rise more rapidly, but Japan's intervention last month to weaken the yen put Tokyo on the hot seat, too. The United States can also expect criticism over its seemingly benign neglect of the sinking dollar, which has led investors to chase bigger returns in emerging markets such as Brazil, driving up asset prices and inflation. "What we all want is a rebalancing of the global economy and this rebalancing cannot happen without ... a change in the related value of currencies," IMF Managing Director Dominque Strauss-Kahn said on Thursday. The currency strains are symptomatic of a deeper problem: most advanced economies are not growing rapidly enough to reduce unemployment despite trillions of dollars in government stimulus spending and emergency loan guarantees. U.S. Treasury Secretary Timothy Geithner may get an unpleasant reminder of that when U.S. monthly employment data is released on Friday -- right in the middle of the G20 breakfast. Economists polled by Reuters think the report will show virtually no net growth in employment, with the jobless rate ticking up to 9.7 percent. For Geithner and most of his European counterparts, options for providing more stimulus are limited because either politics, creditors or both prevent them from amassing significantly larger piles of government debt. Until rich nations find their footing, emerging markets will be the strongest source of global growth. So far, they appear to be up to the task. The IMF expects emerging markets to grow at three times the pace of advanced economies. Those countries are clamoring for greater decision-making power at the IMF, commensurate with their growing economic prowess. This has been another thorny issue for G7 and G20 leaders who have yet to agree on how exactly to divvy up power when no one wants to relinquish their own position. The United States thinks Europe ought to give up some if its seats on the IMF executive board, while European countries have proposed a seat-sharing rotation. IMF officials are scheduled to attend Friday's G20 breakfast, and are hopeful that some progress can be made toward resolving reform issues by a G20 leaders summit in Seoul next month. (Editing by Leslie Adler) Newscribe : get free news in real time Related Video IMF,World Bank try to ease tensions China to further reform of yuan exchange rate formation mechanism:senior official 08:38, October 08, 2010     Increases the bookmark twitter facebook digg Google Windowslive Delicious buzz friendfeed Linkedin diigo reddit stumbleupon China would continue to further the reform of the formation mechanism of its currency (RMB) yuan exchange rate, but a sharp rise in the value of the currency would damage the Chinese economy, a senior official of the People's Bank of China (PBOC), China's central bank, said here on Thursday. "Chinese Premier Wen Jiabao said recently that a steep appreciation of yuan would cause social unrest and serious unemployment problem," Yi Gang, vice governor of the POBC, made the remarks at a Thursday seminar, one part of the International Monetary Fund and World Bank annual meetings program. Yi contended that although some currencies had depreciated against the U.S. dollar during the financial crisis, China kept its currency basically stable, greatly contributing to the global economic recovery. China announced in June this year that it would further the reform of the formation mechanism of the yuan exchange rate to improve its flexibility. Yi noted that Chinese enterprises were still mostly at the lower ladder of the global industry chain. China has registered surplus in trade in goods, but deficits in services trade, and had surplus in processing trade with deficits in general trade. China further deepened the reform of the yuan exchange rate mechanism in July 2005. The yuan has appreciated by 22 percent against the U.S. dollar since then. During this period of time, however, China's trade surplus against the United States has still increased by a large margin, Yi said, adding that yuan appreciation cannot help the United States to solve its trade surplus problem. "We have had surplus in trade with the U.S. and the EU, but deficits in trade with South Korea, Japan and the Association of Southeast Asian Nations (ASEAN). Doesn't all this show that it is an issue of trade structure instead of a mere exchange rate?" Wen said earlier this week in Brussels. China has made big efforts to invest in social safety network building, infrastructures, urbanization process, environmental protection in recent years, to stimulate domestic consumption, industrial restructuring and boost domestic demand, Yi added. Source:Xinhua Newscribe : get free news in real time  Wen's speech at the 6th China -EU Business Summit (Xinhua) Updated: 2010-10-07 18:20 BRUSSELS - The following is the full text of Chinese Premier Wen Jiabao's keynote speech delivered at the 6th China-European Union Business Summit here on Wednesday: Confidence was the keyword of my speech at the China-EU Business Summit two years ago when the financial crisis just broke out. Today, the keywords are calmness, wisdom and courage. With so many Chinese and European business leaders sitting in front of me, I would like to focus on several issues the EU business community is concerned with and use this opportunity to make a few clarifications so as to eliminate misunderstandings and boost our cooperation. It is a basic fact that the bilateral trade and investment between China and the EU have been growing rapidly. EU statistics show its overall exports declined in 2009 due to the impact of the financial crisis. However, its exports to China increased by 4 percent. In the first half of this year, EU exports to China surged by as much as 42 percent. Last night, I paid a brief visit to Germany. I told Chancellor (Angela) Merkel that the monthly bilateral trade between China and Germany averaged about 10 billion US dollars, and that the 2010 total would probably surpass 120 billion dollars. The trade between China and the EU was worth some 400 billion dollars in 2009, and it would likely exceed 500 billion dollars this year. These are the basic status quo and facts. Related readings:  ROK FM to attend IMF-WB meeting ahead of G20 Summit  ASEM summit kicks off in Brussels Nations hope ASEM Summit will help bind them closer together  Introduction to China-EU summit  Cambodian PM to attend ASEM 8 summit in Brussels On the exchange rate of the Chinese yuan, I said yesterday when meeting with the Euro Group troika that European political and business leaders should not join the "chorus" to pressure China to appreciate the yuan.  Again, let's take a look at some basic facts. The yuan has appreciated by an accumulated 55 percent in terms of the real effective exchange rate since China initiated the reform of the yuan exchange rate mechanism in 1994. Some major currencies have all depreciated during this period. China further deepened the reform of the yuan exchange rate mechanism in July 2005. The yuan has appreciated by 22 percent against the US dollar since then. During this period of time, however, China's trade surplus against the United States has still increased by a large margin. We have registered surplus in trade in goods, but deficits in services trade. We have had surplus in processing trade, but deficits in general trade. We have had surplus in trade with the US and the EU, but deficits in trade with South Korea, Japan and the Association of Southeast Asian Nations (ASEAN). Doesn't all this show that it is an issue of trade structure instead of a mere exchange rate? The euro exchange rate experienced large fluctuations recently, but it was caused by the US dollar, instead of the yuan. How can you place the blame on China? The imbalance of trade is caused by structural problems against the backdrop of globalization. It should not be politicized. We pursue balanced and sustainable trade, and in no way seek surplus. In the cold winter in January 2009, I visited Europe and brought with me not only the confidence needed to overcome the financial crisis, but also a procurement delegation to place orders to the European countries. The EU is a strategic partner to China, and China did not look on unconcerned when some eurozone countries were in trouble. We continued to hold and buy euro-denominated bonds and helped Iceland, Greece, Spain, Portugal and Italy in their most difficult time. We will continue to render assistance and tide some countries over their difficulties. China is a friend indeed and I believe the entrepreneurs here all know it. You should not pressure China on the yuan's appreciation if you consider the issue from another perspective. Many Chinese export enterprises have profit margins of only 2 to 3 percent, 5 percent at most. Should the yuan appreciate by 20 to 40 percent, as demanded by some people, a large number of Chinese export enterprises will go bankrupt, the workers will lose their jobs and the migrant workers will have to go back to the rural land, making it hard for society to remain stable. The world will by no means benefit from a crisis in the Chinese economy. China contributed about 50 percent of the global economic growth in 2009. It is a huge market with great potentials for many enterprises. Once again, I would like to tell our friends in the industrial and business community candidly: Don't pressure China on appreciation of the Chinese yuan. We will stick fast to the reform of the yuan exchange rate mechanism. The reform involves developing a managed floating exchange rate system based on the market supply and demand and adjusted to a basket of foreign currencies, to gradually allow more flexibility in the yuan exchange rate while maintaining its basic stability on a reasonable and balanced level. If the yuan exchange rate is unstable, enterprises will also be unstable. So will be employment, and society in general. Should China have problems in economy and society, it will be disastrous for the world. The second question is whether the investment environment in China is good or not. I would like to tell you that China will steadfastly push forward its reform and opening-up process and will in no way deviate from the path. Only through reform and opening to the outside world will China develop further. The basic policies that have been established in the reform and opening-up drive will not be changed. The only changes that have taken place are that foreign investment is now under better and more orderly regulation. Entrepreneurs' concern for the investment environment does not go beyond three aspects -- intellectual property, innovation and government procurement. I can tell you in a responsible manner that all foreign businesses that are legally registered in China are entitled to enjoy national treatment, and that all products made by foreign-invested enterprises in China are made-in-China products. We will protect not only your intellectual property, but also all your legitimate rights and interests. The third question regards the export of raw materials, specifically the export of rare earth. As a long-time researcher on rare earth metals, I have a say on the issue. There are two kinds of rare earth metals, the heavy rare earth elements and the light rare earth elements. China has rare earth deposits in different regions, with the heavy ones located mainly in the south, such as Jiangxi Province. The light ones are mainly in the north, such as Baotou City in Inner Mongolia. In the 1980s and 1990s, there was a lack of well-regulated management over rare earth metals in China, and also a lack of extraction technologies in the country. Some countries bought a large amount of rare earth metals from China at low prices in a period of time when management over rare earth in China was the most chaotic, and even now they still have a considerable stockpile, which they know very well. China contributes a large proportion of the global rare earth output, which far outdoes its share of the world's total rare earth deposits.  We haven't imposed, and will not, impose an embargo on the industry. We are pursuing a sustainable development of the rare earth industry, not only to meet the demand of our own country, but also to cater to the needs of the whole world. We not only need to accommodate the current demand, but also, more significantly, need to take a long-term perspective. It is necessary to exercise management and control over the rare earth industry, but there won't be any embargo. China is not using rare earth as a bargaining chip. We aim for the world's sustainable development. China wishes to forge more extensive, deeper and closer economic and trade ties with EU countries. The EU is now China's largest partner in terms of trade and investment,ahead of the United States and Japan. To be frank, the EU has done a better job in relaxing restrictions on high-tech exports to China. For instance, there is cooperation on the Galileo satellite project, with Airbus and there is nuclear power cooperation, to name a few. This morning, the Belgian King also mentioned to me about cooperation on the fourth generation micro-nuclear technology. It is in the fundamental interests of both China and the EU to develop bilateral trade and economic relations. Standing here today, I am feeling under a heavy responsibility. I will try my best to promote China-EU trade and economic cooperation and overcome the temporary difficulties and problems that have emerged in the process of cooperation. So, let's join hands to promote the development of China-EU trade and economic relations and jointly usher in broad prospects for future development of the China-EU comprehensive strategic partnership. Newscribe : get free news in real time

China's Competitive Edge In The Outsourcing Space

Egidio Zarrella, 10.07.10, 06:25 AM EDT

China's calculated move from being the world's factory to becoming the world's back office is increasingly becoming a reality, as our recent outsourcing survey finds.

Egidio Zarrella

China’s size, infrastructure and talent pool all indicate a promising future for outsourcing over the coming decade. The numbers speak for themselves: in 2009, industry revenues totalled $13 billion and they are projected to grow to $44 billion by 2014, according to IDC KPMG analyses and Datamonitor.

As China comes to the fore in this space, India remains ahead of the game, which is not surprising given it has a 20-year lead in this space. To put it in context, the vendor industry in India is worth around $60 billion, whereas in China it is a fledgling industry, worth around $25 billion. However, the key point is that it is no longer an India play, as multinationals are increasingly opting to have a balanced portfolio, with outsourcing centers located in a number of countries and regions. This is in order to mitigate potential social, economic and political risks, and to avail of favourable government incentives, which tend to vary from country to country.

China’s outsourcing industry has also been shaped by different factors to those of India. Its growth has been founded on the domestic market as well as nearby overseas markets such as Japan and Korea. It continues to branch out into new markets, taking advantage of its strong infrastructure and talent pool, as well as diverse language skills. Our latest survey (KPMG Pulse Survey: Shared Services and Outsourcing in China) confirms the extent to which outsourcing has become prevalent amongst organizations across Asia. These activities are no longer the preserve of US and European companies looking to offshore their back office functions.

Eighty-one percent of the 280 Asia-based respondents said they had a strategy that involved outsourcing. China was their number-one choice of location, ahead of India and Singapore. Most respondents said they had outsourced to more than one other country, with many still choosing more developed hubs like Singapore and Hong Kong as well.

It is important to note that Asian companies outsource just as much as their Western counterparts, as they all look for efficiencies in their supply chains. To illustrate this point, the survey indicates that almost 80% of respondents either have shared services in one location or two, as well as outsourcing various functions.

One of the key drivers to outsource is that of demographics. Australia, Korea and Japan are aging populations, and as a result they are increasingly tapping into the workforce of countries like China, India, the Philippines and Malaysia. In contrast to India, where the industry moved up the value curve sequentially, it appears that IT Outsourcing (ITO), Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO) functions are all emerging simultaneously in China. This is a seismic shift as China increasingly becomes home to more of the world’s intellectual firepower.

China’s scale--and the number of potential outsourcing cities and service providers to choose from--offers huge opportunity for the market ahead of its competitor nations. Organizations are able to source multiple suppliers within one country, which reduces their dependence on a single location or supplier. It has a large domestic market, a government that invests heavily in infrastructure and a large pool of graduates that form the workforce. It offers good logistics operations, in addition to competitive wages. It does now need to shift from manufacturing into services, in order to maintain its competitive edge. Its main consumers in Europe and the US are purchasing less and this means their importance to China will lessen as its economy continues to expand. There will be less opportunity to sell its goods to overseas markets. This will equate to steady volume growth, while margins continue to fall and investment in factories and equipment will decline. Hence the need to shift its focus to services.

Current developments are encouraging, as we continue to see China’s political leadership support the growth of the outsourcing sector. This is evidenced by the series of Five Year Plans, where the foundations were laid for the development of the service outsourcing industry. There are now twenty-four designated outsourcing cities and over 9,000 service providers in China.

While India has tended to provide outsourcing for US and European organisations, China has mainly serviced the Korean and Japanese markets, partly due to geographical proximity and similar time zones. Our survey found that outsourcing strategies are no longer just about cost arbitrage. Equally or even more important is the need to ensure access to a reliable supply of abundant and skilled talent. China’s workforce boasts an impressive array of language skills, both Asian and European.

The government has made English a priority in schools and universities, boosting the country’s ability to win business from western markets. Another source of high quality skills is the large number of Chinese returnees who have the much needed project management experience. While China has a massive pool of outsourcing professionals, special domain expertise is crucial in order to maintain a competitive edge.

Government support continues to play an important role, with more encouragement being given now to domestic companies to outsource as well. China plans to train 1.2 million service outsourcing professionals by 2013, while 1 million college graduates are expected to find jobs in this sector within the same time frame. Financial subsidies for training and tax incentives also help to drive more interest in this sector.

Infrastructure is crucial, as without adequate telecommunications and transportation networks, it is difficult to attract investors and multinationals. China has invested heavily in a modernized telecommunications network with high-speed broadband connections in the major cities. It has also developed technology parks to further attract multinationals to locate here.

China has also made rapid progress in the development of shared services facilities. Accounting and finance already surpass IT as the most common functions being conducted by shared services centres in China, while HR functions are increasingly being outsourced or offshored. In terms of moving up the value chain, as service providers expand and the industry continues to mature, many are providing higher-value services. The government has also initiated a drive to encourage multinational corporations to set up research and development (R&D) centers in China. There are now over 1,200 R&D centers established by multinationals across China, benefiting from the vast R&D talent pool, according to numbers provided by the Ministry of Commerce.

It is also increasingly looking at the potential of its domestic market, particularly for automotive, telecommunications and financial services. Historically, the domestic service providers have primarily served the local government and state-owned enterprises (SOEs). While they may have an edge over the international players in the local market, they are limited by their size and experience of managing large scale and complex projects. The anticipated domestic demand on outsourcing services is a major differentiator compared to India, where the outsourcing industry is more offshore demand-driven.

No one destination will offer everything on the checklist and a new paradigm is emerging in which multinational companies assess several attractive markets, scoring them on their existing strengths. Companies increasing want global sourcing, not simply from India or China, but from both. As Chinese companies grow in size and complexity, the business case for setting up outsourcing arrangements becomes stronger. India remains a juggernaut in this space however the key differentiator for China is the rising potential of its domestic outsourcing industry.

Egidio Zarrella is a Partner in the Advisory practice at KPMG China.

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Currency wars ! China warns against rapid rise in yuan, IMF warms, Global central banks may act, Weak US dollar fuels financial bubble fears !

Wen Jiabao tells EU to stop pressuring Beijing to revalue the yuan or risk unleashing serious social unrest in China

• Julia Kollewe and agencies
• The Guardian, Thursday 7 October 2010
• Article history

 

China's Wen Jiabao rejected calls for a rapid appreciation of the yuan. Photograph: Koji Sasahara/AP

The war of words over international currency valuations escalated yesterday when the Chinese premier Wen Jiabao told the European Union to stop pressuring Beijing to revalue the yuan as any rapid shift risked unleashing serious social unrest in China.

Speaking in Brussels, Wen said that China would move towards making its currency more flexible but he rejected calls for a rapid appreciation as the issue threatened to dominate this weekend's meeting of the International Monetary Fund and G7 countries in Washington.

"Do not work to pressurise us on the renminbi [yuan] rate," Wen said, departing from a prepared speech on the sidelines of a summit with EU leaders. "Yes, we are going to proceed with the reforms."

China has been criticised by the EU and even more so by the US for pegging its currency at a low level, meaning that its exports are cheaper worldwide, hindering the efforts of western nations to recover from recession via export-led growth.

But Wen said yesterday that China's trade surplus with the US was explained by the specific structures of the two economies, not the yuan exchange rate.

He noted that a US congressman had predicted social unrest in China if there was a rapid rise in the yuan. "Many of our exporting companies would have to close down," Wen said. "Migrant workers would have to return to their villages. If China saw social and economic turbulence, then it would be a disaster for the world."

His remarks come as finance ministers from the G7 are about to discuss growing concerns over currency wars on the sidelines of the annual IMF gathering in Washington on Friday.

Timothy Geithner, the US treasury secretary who visited China earlier this year to plead the case for a higher yuan, said in Washington that a "damaging dynamic" of large economies keeping their currencies undervalued can cause inflation and asset bubbles. He called on countries to co-ordinate their policies.

"More and more countries face stronger pressure to lean against the market forces pushing up the value of their currencies," he said yesterday at the Brookings Institution in Washington. He said currencies are "inherently a multilateral issue. It's much easier to solve if countries come together and do things to complement each other.

Geithner's comments echoed calls by the IMF for greater currency flexibility. The organisation's chief waded into the row, warning governments against using exchange rates as a weapon. Dominique Strauss-Kahn told the Financial Times: "There is clearly the idea beginning to circulate that currencies can be used as a policy weapon. Translated into action, such an idea would represent a very serious risk to the global recovery … any such approach would have a negative and very damaging longer-run impact."

The Bank of Japan reinstated its zero interest-rate policy and pledged to buy ¥5tn (£37bn) of assets, leading to a drop in the yen. In recent weeks it has also intervened in the currency markets to weaken the yen for the first time in six years, although the impact was short-lived.

Brazil has threatened intervention to weaken the real. On Monday, it doubled a tax on foreign investors buying local bonds to put a lid on a recent rally in its currency. Brazil's finance minister, Guido Mantega, coined the phrase "international currency war" last week, following a series of interventions by central banks in Japan, South Korea, Switzerland and Taiwan to make their currencies cheaper.

Strauss-Kahn appeared to refer to Mantega's comments when he said: "We have seen reports that some emerging countries whose economies face big capital inflows are saying that maybe it is time to use their currencies to try to gain an advantage, particularly on the trade side. I don't think that is a good solution."

The weak dollar and expectations that the US Federal Reserve may announce stimulus measures pushed gold to a new record high yesterday. Spot gold hit $1,349.80 an ounce. Silver soared to a fresh 30-year high and platinum reached a four-and-a-half-month peak.

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6 Oct, 2010, 05.41PM IST,REUTERS

IMF warns against currency war, dollar heads lower

 A growing drive by nations to cap the strength of their currencies risks derailing the world economic recovery !

LONDON: The head of the IMF warned that a growing drive by nations to cap the strength of their currencies risked derailing economic recovery while the dollar dropped further on Wednesday.

Concerns that the Federal Reserve is about to embark on another round of policy easing that could weaken the dollar, tallied with China's polite refusal to let its yuan rise fast, has pushed currencies to the top of the agenda at Friday's meeting of finance chiefs from the Group of Seven nations.

Few hold out much hope of any meaningful agreement at the G7 or the International Monetary Fund meeting that follows.

"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 US policy.

The dollar extended its losses on Wednesday, falling to an 8-1/2 month low against a basket of currencies and edging toward a 15-year trough versus the yen.

That trend prompted Japan to intervene to weaken the yen last month and some emerging economies have followed suit or are threatening to.

"There is clearly the idea beginning to circulate that currencies can be used as a policy weapon," IMF Managing Director Dominique Strauss-Kahn was quoted as saying in Wednesday's edition of the Financial Times.

"Translated into action, such an idea would represent a very serious risk to the global recovery ... Any such approach would have a negative and very damaging longer-run impact," he said.

The IMF, which holds its twice-yearly meeting in Washington this weekend, is also expected to discuss foreign exchange moves as part of its mission to get countries working for balanced global growth.

Brendan Brown, economist at Mitsubishi UFJ Securities International in London, said the Fund, which has the United States as its biggest stakeholder, would not try to prevent further US monetary easing or a resulting slide of the dollar.

"That Washington institution has failed in its central mission to prevent currency war ," he wrote in a report.

CHINA UNMOVED

Euro zone policymakers urged Chinese premier Wen Jiabao on Tuesday to allow the yuan to rise more rapidly, but he politely rebuffed them, repeating Beijing's standard line on seeking currency stability.

Wen was due to hold a joint news conference with EU leaders in Brussels at 1515 GMT.

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.

Emerging nations say the cash flows seen this year have damaged their exports due to the determination of major economies to restrain their own currencies' levels.

But entrenched positions make it unlikely that officials sitting down to IMF and G7 meetings this weekend, and G20 meetings later in the year, will resolve their differences. 

Brazil fired the latest shot in what it has dubbed an "international currency war," doubling on Monday a tax on foreign investors buying local bonds to 4 per cent to curb a strong real.

Policymakers from emerging Asian economies have voiced growing concerns about the risk of a flood of hot money inflows. 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.

MORE FED EASING?

Adding to speculation that the Federal Reserve will soon extend asset purchases to pump money into the economy, Chicago Fed President Charles Evans was quoted as saying the central bank should do much more to spur the economy.

And in a surprise move, Japan pulled interest rates on the yen back to zero on Tuesday and pledged to pump more funds into an economy struggling to compete while the currency remains close to a 15-year high against the dollar.

The euro gained 7.6 per cent versus the dollar last month as Fed easing speculation hotted up. Europeans are worried they will be saddled with an overvalued currency, stifling recovery, because they have few tools to contain the euro's rise.

France, which takes over the presidency of the Group of 20 major economic powers next month, has put reforming the international monetary system at the top of its agenda, hoping to draw China into multilateral talks on currency coordination.

Global Central Bank Action May Follow BOJ Moves

Wednesday, 06 Oct 2010 11:46 AM

 The Bank of Japan may have acted first in a new round of central bank action to prop up the global economy as recoveries in industrial nations falter.

The unexpected decision by the Japanese central bank yesterday to drop its interest rate to “virtually zero” and expand its balance sheet follows the U.S. Federal Reserve’s move toward more unconventional easing. Bank of England officials will consider further stimulus tomorrow, while the central banks of Australia, Canada and New Zealand are among those now holding fire on further interest-rate increases.

The renewed push for easier monetary policy comes as the International Monetary Fund warns growth in advanced economies is falling short of its forecasts ahead of its annual meetings in Washington this week. The dilemma for policy makers is that their actions may do little to revive growth and end up roiling currency markets.

“The Bank of Japan is at the head of the pack,” said Stewart Robertson, an economist at Aviva Investors in London, which manages about $370 billion in assets. “It looks like a lot of others will follow. Whether it’s right or not is another matter.”

Group of Seven ministers will gather Oct. 8 in Washington, on the sidelines of the IMF meeting. Currency issues will be discussed, Canadian Finance Minister Jim Flaherty, who will chair the meeting, said this week. Japanese Finance Minister Yoshihiko Noda said he’s ready to explain his country’s actions at that meeting.

BOJ Move.

The Bank of Japan cut its overnight call rate target from 0.1 percent and established a 5 trillion yen ($60 billion) fund to buy government bonds and other assets. It moved as the yen’s surge to a 15-year high last month hurts exports and damps economic growth. The yen traded at 83.13 per dollar at 2:32 p.m. in Tokyo, close to a Sept. 15 record of 82.88.

The central bank said today that weaker exports and slower global growth are causing the nation’s rebound to moderate. “Japan’s economy shows signs of a moderate recovery, but the pace of recovery is slowing down,” the bank said in a monthly economic report released in Tokyo.

‘Vicious Spiral’

Bank of Japan Governor Masaaki Shirakawa may not be alone for long in taking action and Daiwa Institute of Research argues he’s now engaged in a “vicious spiral” of monetary easing with the Fed as both compete to bolster their economies.

“The BOJ’s next moves will depend on the Fed,” said Maiko Noguchi, an economist at Daiwa in Tokyo. “The bank will have no choice but steadily take easing measures.”

Fed Chairman Ben S. Bernanke and his colleagues have signaled they may announce the purchase of more Treasuries as soon as their next policy meeting on Nov. 2-3 in an effort to boost growth and reduce an unemployment rate stuck near 10 percent for the past year.

“The irony is that the Fed is creating all this liquidity with the hope that it will revive the U.S. economy. It is doing nothing for the U.S. economy and causing chaos for the rest of the world,” Joseph Stiglitz, a Nobel Prize- winning professor at New York’s Columbia University, said today in New York.

Quantitative Easing

Bernanke said on Oct. 4 that the Fed had aided the economy by buying $1.75 trillion of mortgage debt and Treasuries from August 2008 through March 2010. Pacific Investment Management Co. says a new round of quantitative easing, the policy of creating money by enlarging the central bank’s balance sheet, is “likely.”

“The bottom line for the U.S. is a growth trajectory so slow you’d nearly call it stalled,” Paul McCulley, a portfolio investor at Pacific Investment Management Co., wrote on the company’s website this week.

Steven Englander, New York-based head of Group of 10 currency strategy at Citigroup Inc., said he anticipates the dollar will continue to fall, with the euro likely to pass through $1.40 from $1.37 yesterday. The dollar has already dropped 7 percent against the euro since the start of September.

Asset Purchases

At the Bank of England, policy maker Adam Posen made the strongest call yet on Sept. 28 for the U.K. central bank to resume asset purchases after keeping its bond-buying program at 200 billion pounds ($317 billion) for the past 11 months. That proposal lays the ground for the first three-way split when the Monetary Policy Committee meets tomorrow, with member Andrew Sentance advocating higher interest rates.

“At the present time, the growth threat is more of a danger than inflation,” said Graeme Leach, chief economist at the Institute of Directors, a London-based business lobby group. “Yes, inflation is above target now. But a double-dip recession would raise the specter of deflation.”

The revival of quantitative easing is a reversal from earlier this year, when central banks were halting stimulus or debating how to tighten policy. What’s changed is the loss of momentum in industrial economies.

Global Slowdown

John Lipsky, the IMF’s No. 2 official, said on Sept. 27 that global growth in the second half of the year will fall short of the fund’s 3.75 percent forecast. The Washington- based lender revises its outlook today.

While not yet looking to buy assets, some central banks are suspending their interest-rate increase campaigns.
After embarking on the most aggressive policy tightening in the Group of 20, the Reserve Bank of Australia unexpectedly left its benchmark rate unchanged yesterday at 4.5 percent for a fifth straight month. Bank of Canada Governor Mark Carney, who has overseen three rate hikes this year, said Sept. 30 that “the unusual uncertainty surrounding the outlook warrants caution.”

Not all policy makers are changing course. The central banks of Israel and Taiwan raised borrowing costs in the last ten days and the European Central Bank, whose Governing Council convenes tomorrow in Frankfurt, has indicated it wants to continue withdrawing liquidity support for banks.

‘Fully On’

The ECB will be forced to postpone tighter policy as European exports fade and investors continue to fret about peripheral euro-area economies such as Portugal and Ireland, said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Inc. in London.

“The ECB’s exit strategy is fully on, but the business cycle will turn against them,” said Peruzzo. “The communication will then be adjusted to consider downside risks greater than what they have anticipated.”

The ECB last week stepped up its government bond purchases as the cost of insuring against default on Portuguese government debt surged to a record and Irish bond spreads soared to euro-era highs.

Bolster Expansion

The question for those central banks leaning toward buying more assets is whether doing so will actually bolster expansion, said Charles Dumas, director of international research at Lombard Street Research Ltd., a London-based consultancy.

“Is quantitative easing going to cause people to spend more? I don’t think so,” he said. “It does add value in reducing the risk of a downward spiral in markets.”

Another risk is that the use of unconventional monetary policy is viewed as an effort to weaken currencies to boost exports, rising competitive devaluations and protectionist responses, said Eric Chaney, chief economist at AXA Group in Paris. Japan, Switzerland and Brazil are among the countries that have already intervened in markets to restrain their exchange rates.

“This is close to a currency war,” said Chaney, a former official at the French France Ministry. “It’s not through exchange-rate manipulation, but through monetary policies.”

© Copyright 2010 Bloomberg News. All rights reserved.

Weak US dollar fuels financial bubble fears!

By IZWAN IDRIS  October 7, 2010
izwan@thestar.com.my,

Emerging markets stepping up measures to control speculation!

PETALING JAYA: There is rising concern that the weak US dollar is fuelling new financial bubbles in emerging markets.

A growing number of Asian and South American countries, whose currencies had seen unwarranted appreciation, are stepping up control to curb speculative short term investments from overseas.

The flood of investment money into emerging market is expected to reach US$825bil this year, according to the latest estimate by Institute of International Finance (IIF) on Monday.

This is higher than the previous forecast of US$709bil it made in April. Last year’s figure was US$581bil.

The Malaysian ringgit, like other emerging market currencies, has been rising steadily against the greenback. — AP

 

Analysts expect capital flows from advanced economies into emerging markets to remain strong as long as central banks in developed nations continue to pursue a loose monetary policy.

Earlier this week, South Korea and Brazil announced plans to increase measures aimed at discouraging disruptive capital flows.

CIMB Research, in a recent note, said instead of imposing tough capital controls on inflows, central banks in South Korea, Taiwan and Indonesia had implemented quasi-capital controls by restricting currency derivatives and imposing a minimum holding period.

But the trend in capital flows from advanced economies into emerging markets will likely continue because the widening yield gap is in the emerging markets’ favour.

Growth prospects are also stronger and there are lingering worries about sovereign credit quality in mature economies,

CIMB Research said the “push and pull” factors are reinforcing competition to attract private capital flows into emerging economies.

Reuters reported yesterday that the falling dollar had escalated a global currency war, and that the exchange rate issue was now expected to top the agenda as finance officials from around the globe meet this week starting with those from the Group of 7 tomorrow followed by the International Monetary Fund (IMF) over the weekend.

Ultra low interest rates in Europe and Japan and concerns that the US Federal Reserve is about to embark on another round of money printing could weaken the dollar further.

This could result in further appreciation of emerging market currencies to a point that it would start to hurt exports.

London’s Financial Times reported yesterday that the head of IMF had warned that governments were risking currency wars if they tried to use exchange rates to solve domestic problems.

At the same time, emerging countries are also increasingly edgy about the flood of capital inflows from advanced economies.

The massive inflows had sent Asian stock indices, as well as their currencies, to or near record highs.
“If the situation continues for a while and Asian currencies continue to appreciate, there is a possibility that emerging Asian economies may have to do something to protect their interests.

“This may lead to, perhaps, some form of tax on capital inflows,’’ said Peck Boon Soon, an economist at RHB Research Institute.

In his report, Peck noted that overseas investors held 27% of Indonesia’s local currency government debts as at end-July, compared with 16% a year earlier.

In Malaysia, foreigners owned 18.8% in July versus 10% a year earlier.

Demand for Asian currency-denominated debts was so huge that the Philippines’ US$1bil worth of peso bonds directed at global investors was oversubscribed by 13 times.

Investors were so bullish that the Philippines was able to sell the bonds at just 5% yield. Based on Moody’s Investors Service’s calculation, the yield implied the bonds were rated at A3 by investors, which was six notches higher than the firm’s rating.

The weak US dollar also boosted the price of gold – viewed by some as the leading reserve currency – to a new all-time high of US$1,349.80 an ounce yesterday.

At home, the ringgit rose for the first time in two days to 3.0925 against the US dollar. The local currency hit a 13-year high at 3.085 last week.