Need To Address Unfair Undervaluation Of Currency

Trade is a two sided activity. Sustainability of international trade depends on its fairness, and a good medium of exchange is one of the essential prerequisites for that. The various economic crisis during the last two decades, and the underlying role of undervalued currencies of certain countries has repeatedly reaffirmed that the global trade badly needs a currency that is not only stable but also ensures fair trade practices essential for global economy.
Need to Address Unfair Undervaluation of Currency
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Role of Currencies in Global Economic Crisis

The 2007 economic crisis that engulfed the whole world in its grip today had its roots in the mammoth trade deficit that the United States has been suffering from in the years preceding the crisis. This deficit, on current account, which was approaching a trillion dollars per annum at its peak, has largely been a result of two factors - undervalued Asian currencies, particularly the Chinese Renminbi, and the rising crude bill. While the crude price has fluctuated a lot in the last decade, but now come back to where it was before the

asset bubble, the undervalued renminbi and resultant trade deficit of United States with China will probably continue to exist and swell. This can lead to persistent vulnerabilities in the global economy and threaten instability, not only for the economy of  United States, but also the rest of the world including China.

History of International Medium of Exchange

International trade reached its zenith during the beginning of twentieth century, in spite of all the difficulties in communication, transport and lack of global peace. One of the main reasons for this was the effective medium of exchange that prevailed during those times, in the form of gold. Gold was a precious commodity which had its own inherent value that gave its owners significant security of their wealth, a crucial factor in their indulgence in international trade.  More importantly, during this age of Gold standard, the limited availability of gold ensured stability in two ways. On one hand, creating additional currency was not easy and even if created, it was free from the side effects of seignorage (printing of additional paper currency), and on the other hand, transfer of gold from one country to another as a result trade imbalance immediately caused the price of goods of trade deficient country to fall, thereby resulting in rise in its exports that rebalanced its international trade. Unfortunately, this advantage of gold as currency was not enough to counter the drawbacks of its limited availability in the face of expanding global economy.

The Bretton Woods Systems

During modern times, the Bretton Woods system was the closes alternative to the gold standard, during which all countries maintained fixed value of their currencies in relation to U.S. dollar, which in turn was linked to gold. Once it was broken, it was only a matter of time that the lack of a good medium of exchange will bring its own disasters. No surprise then that the economic history of post-Bretton Wood's era is replete with currency crises across the world, the last of which has come in a very different form, and is currently threatening to damage the whole global economic health.

The Chinese Renminbi, its Trade Surplus & Economic Stability

The Chinese Renminbi has practically remained fixed to the U.S. dollar in the face

of a combined Chinese current and capital account surplus that has fed its foreign exchange reserves to unprecedented heights. Such wilful undervaluation of Renminbi has come at the cost of undervaluing the labor and wealth of Chinese citizens, a factor that artificially restricts their ability to import goods from other countries and allows their products to beat all competition. It has been sustained primarily due to the extremely high saving rates of Chinese households that approximates 40% of their earnings, and an authoritarian government that none of the citizens or businesses dare to question. This artificial undervaluation, leads, on one hand to exploitations of its own citizens, and on the other creates a kind of trade imbalance that cannot sustain itself for too long.

The Chinese foreign exchange reserves need to be parked somewhere, and expectedly, they find their way back to the U.S. economy in the form of investments in government treasuries and all other kind of investments, including stocks, commodities, real estate and oil. This leads to high demand of assets in United States, thereby leading to rise in their prices. As the asset prices boom and as money from China and the Middle East keep flowing back, it distorts the U.S. economy in a way that will be difficult to rectify in the short run. The underpriced Chinese products shift manufacturing and production away from United States to China thereby reducing income of U.S. citizens, while the rising asset prices give a false feeling of 'wealth creation' that is enough to fool U.S. consumers to consume even more. The result, a further rise of trade deficit, was always unsustainable, but the world comes to realise that only when the asset bubble bursts. Unfortunately, by the time we realise, it is too late. The crisis has already set in.

Any crisis in the future will be managed, sooner or later, but only after a lot of suffering and pain. However, the root cause of the problem, till it is there, will keep the global economy vulnerable to more such events. It is time we find a fair and sustainable system of managing international currencies and their exchange rates. The easiest would be acceptance of a uniform exchange management system that all major countries who wish to be global players must accept and implement, in letter and spirit.

We desperately need a good medium of exchange for international trade, and we will get that only when all countries accept a rule bound fair system of managing their currency exchange rates.

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