Revisiting ‘gold-backed’ East Asian currency

Politicians often yell about currency manipulation in an attempt to prove their toughness on foreign policy. They tend to criticise currency manipulation in campaign speeches, congressional committee meetings and debates to prove to constituents that they will be tough on countries trying to cheat the free market. All too often they seem underinformed about the subject.

In recent years, a substantial amount of political rhetoric in the United States has been aimed at addressing the “problem” of China’s currency manipulation. The media has given particular prominence to China’s currency manipulation, which began concurrently with China’s admission to the WTO.

History of currency manipulation

Currency manipulation occurs when a country artificially inflates or deflates its exchange rate. It is when a government buys or sells foreign currency to push the exchange rate of its currency away from its equilibrium value or to prevent the exchange rate from moving towards its equilibrium value.

One way a country can devalue its currency is to print more money, and then use that new money to buy foreign debt and foreign currency. Such move will increase the supply of its currency and hence lower its value against the target country’s currency where the supply decreases.

Countries may manipulate their currency for a number of reasons: to boost currency account surpluses, for political gain, to avoid inflation, to make exports more competitive, or to reduce the inflow of capital into their country. Currency manipulation often causes many harmful effects, both to the domestic manufacturing industries of the non-manipulating countries and, on a larger scale, to the overall amount of world trade.

Dangers of currency manipulation can be learnt from the 1920s and 1930s. In fact, currency manipulation played an important role in escorting in the Great Depression as nationalistic currency wars rose in an already weak global economy. Countries started to devalue their currencies in an attempt to boost their exports and rescue their struggling economies. This ignited a “race to the bottom”, where devaluation of their currency is an attempt to boost their exports in the short term. The competitive devaluation ruined the manufacturing industries as the market for imports and exports was effectively broken.

After World War II, the international community stopped this madness that also fuelled inflation. At the 1944 Bretton Woods Conference, the major powers created the International Monetary Fund (IMF) and the World Bank. Three years later, the General Agreement on Tariffs and Trade (GATT) was finalised, indicating a shift from laissez faire economics to a regulatory regime designed to prevent the race to the bottom, which hastened the economic collapse of the Great Depression.

This was the first time that an international organisation purported to regulate inter-state monetary affairs. The IMF was charged with overseeing the international monetary system to ensure exchange rate stability and encourage its member countries to eliminate exchange restrictions that hinder trade. It worked well for the next three decades.

Unfortunately, the stability of exchange rates ended in the late 1960s. Countries began to desire more flexibility and sovereignty over their currencies, and by 1971, the gold standard system had completely fallen apart. In 1971, the IMF’s Board of Governors agreed on an amendment to the Articles of Agreement effectively recognising that the gold standard system was no longer in force. This amendment allowed IMF members to set their exchange rates as they saw proper.

Alternative currency will take time

The topic of currency manipulation seen as a “de facto” trade subsidy is gaining importance in today’s environment. The ongoing spat between the United States and China, and the fear of it escalating into a “full-blown” trade war has raised eyebrows, especially in the global economic environment which is moderating. More recently, the United States has classified countries like Japan, South Korea, Germany, Italy, Ireland, Singapore, Malaysia and Vietnam as currency manipulators.

To resolve the issue, both the IMF and WTO should cooperate. The IMF seemingly has a stronger jurisdictional basis for policing exchange rates but lacks meaningful enforcement capabilities. The WTO, on the other hand, has some enforcement capability but has jurisdictional hurdles. Cooperation between the two organisations would solve these major issues but is unlikely for a number of reasons.

In the absence of an international remedy, unilateral action by the affected country takes place. One of it is the imposition of tariffs, which is a justifiable countermeasure in response to currency manipulation by other nations. However, tariffs are probably not an adequate solution for addressing currency manipulation. Universal tariffs would likely cause more harm than good. Country-specific tariffs might be effective, but carry significant risks of retaliation and trade wars. Industry-specific tariffs carry fewer risks but operate on such a small scale that their ability to combat the problem is limited

Meanwhile, for years, various world powers have discussed replacing the US dollar as the world reserve currency. The BRICS nations have discussed their own currency to compete with the US dollar. For instance, both Russia and China took steps toward so-called “de-dollarisation” with the opening of a yuan clearing bank in Russia.

They have openly complained that the US dollar is no longer able to fulfil its role of global currency.

Calls for an alternative Asian currency backed by gold revived. Today, essentially we are in a “non-gold standard” monetary version. While some foreign currencies are pegged or essentially pegged to the US dollar, the US dollar is not pegged to anything.

Countries around the world have tied the fate of their currencies and their population’s welfare to a currency they do not control, merely on the basis that the United States will never fail. This can become tricky.

Any new East Asian currency is only truly “backed by gold” if it is convertible to gold.

There is something intuitively appealing about the idea of a gold-backed currency – money backed by the tangible value of gold, i.e. “the gold standard”. Instead of intrinsically worthless paper money (fiat currency), gold-backed money would have real, enduring value – it would be “hard currency”, i.e. sound money, because it would be convertible to gold itself. The US dollar was backed by gold until US President Nixon ended the US dollar’s gold standard in 1971.

Russia and China were creating a framework to eventually clear transactions in gold, bypassing the dollar entirely. They aim to make more of their transactions in gold because both of them have been accumulating gold reserves at a rapid pace compared to other countries, and the BRICS nations are gold producers.

Meanwhile, China, Russia, Iran and Turkey – the four key vectors of ongoing Eurasia integration – are investing in bypassing the US dollar on trade by any mechanism necessary. To replace the US dollar may not be so simple. Russia and China plan to ditch the US dollar and switch to local currencies in international trade. But the setback for the new payment infrastructure shows just how difficult it is to shift away from the US-dominated status quo. The process of introducing an Asian common currency will be a long-term endeavour, requiring strong political will within the region and considerable time and effort.

Anthony Dass, chief economist/head, AmBank Research & Adjunct Professor of Economics, UNE, Sydney, Australia.

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