World needs to stay vigilant about active depreciation of the dollar

By Li Xiangyang, translated by People's Daily Online

A currency war is spreading as the dollar's value against major world currencies has continued to decline in recent days. Some developed countries have begun to intervene in their exchange rates. The recovery of the global economy will suffer a negative impact if this trend is not checked.

It is the dollar that triggered the currency war. Seemingly a market move, the depreciation of the dollar is actually active.

The U.S. Federal Reserve's statement that it might restart quantitative easing — a policy central banks use to increase money supply — triggered the depreciation of the dollar. The dollar's value against the basket of currencies has decreased by 7 percent since the U.S. Federal Reserve began talk of possible quantitative easing.

The move nominally aims to further drive down the interest rate in America to prevent the occurrence of a double dip. But it will affect the value of the dollar too, prompting the dollar's devaluation. In light of the history low short-term interest rates in the United States, a further decrease in the interest rate will drive the flow of short-term capital toward markets of emerging economies, quickening the appreciation of their currencies.
　
Second, the U.S. government's strategy to double its exports within five years needs the considerable depression of the dollar. For America, boosting exports is a must in the post crisis era, because it cannot pin its hope for economic growth on the prosperity of its real estate market and consumption based on borrowing money.

Obviously boosting exports relying on the competitiveness of U.S. companies is not realistic in the short term. Nor is it possible to be realized by the strong demand of its trade partners. None of America's trade partners — except those emerging economies — are able to achieve growth independently. Judging from the course of history after World War II, considerable depreciation of the dollar is the sole possible option that enables America to realize the goal. In this sense, driving down the value of the dollar has become an important choice in policy for the United States to recover the sluggish economy..

The last but the most important point is that in the long run the considerable depreciation of the dollar will help America to transfer its debts to others. If we say the international financial crisis nationalized the private debts, then in the post-crisis era, the United State sees an urgent need to internationalize its debts.

A great amount of bad debts of American financial institutions have been converted to government debt through government aid measures. In 2009, America's fiscal deficit stood at 1.42 trillion dollars, 3.1 times the 2008 level. The deficit ratio surged from 3.2 percent in 2008 to 10 percent to a new high since World War II. The debt of the federal government increased to 6.7 trillion dollars, representing 47.2 percent of its GDP. In 2010, the fiscal deficit is expected to be around 1.32 trillion dollars. How America retains economic growth while reducing the deficit is a big problem for the country.

Historic experiences show debt-to-GDP ratio is not directly linked with economic growth and inflation (even devaluation) in most countries. But the United States is an exception because the dollar serves as the world currency. For instance, the ratio decreased from 121.2 percent in 1946 to 31.7 percent in 1974. Of that number, inflation accounted 52.6 percentage points, economic growth contributed nearly 56 percentage points and federal surplus contributed negative 21.51 percentage points. Even if the United States denies its motives to transfer their debts, it will unavoidably happen in reality.

Given a sluggish economy and huge amount of debts, driving the value of the dollar down is in line with America’s interests, both in short term and in long term. The international community ought to stay vigilant about the strong motive for active devaluation under the guise of a market-based move.