Wang Xiaolong

For the time being, the chances of an imminent currency war are receding, thanks to the last-minute show of solidarity and the compromise struck at the G20 Finance Ministers and Central Bankers' meeting in Korea over the weekend. Yet the prospect of forestalling a tug-of-war on parity between currencies or lack of it is far from assured. The debate will continue on the diagnosis and the prognosis as well as prescriptions, to which I wish to add the following perspectives on two of the issues gaining widespread attention.

Let me start on quantitative easing (or QE), adopted by the US Federal Reserve as a major monetary policy tool to buttress the faltering economic recovery and combat deflation in the US. Joseph Stiglitz has written a potent piece on why easier money will not work ( see WSJ on Oct. 25). On top of his line of reasoning, I would argue that instead of pouring oil on troubled waters in the US, a further round of QE could pour oil on flames by exacerbating the disequilibria in the global economy without rectifying its imbalances.

Ideally, QE would work best in a relatively closed economy. The truth of the matter is, however, that we live in a globalized world. A substantial proportion of the liquidity thus generated, instead of powering domestic investment and consumption, end up leaking out of the US economy, flushing the rest of the world already awash with US dollars with even more liquidity.

This is due largely to the glaring and still growing returns gap between the US and the emerging economies, arising from the striking contrast of deep-seated structural malaise and cyclical weakness for the former versus the strength of both the latter's real economy performance and anticipated appreciation of their currencies. This has changed the correlation between monetary policy and aggregate output/price levels. If the domestic impact of monetary policy moves in the US used to be modest but still positive, it is today much more nebulous. Things do not look good on the twin counts of current economic activities, with GDP growth and unemployment mitigation as major indices, and of future potentials using fixed asset investment as a proxy.

To be effective, short-term counter-cyclical monetary tools such as QE have to be combined with policy measures targeting the long-term structural problems in the US economy. Otherwise, it will simply fall short in generating adequate investment opportunities that can yield attractive returns for the money to stay in the system other than by way of creating bubbles. In fact, if investor inflationary expectation is firmly established, there is little doubt in which one direction investment will flow. In that case, the US recovery will continue to be anaemic at best. Yet the desired combination does not seem to be materializing any time soon.

For a policy that will produce little or no effect for the US economy, the global collateral damage is disproportionately high in that the flush of liquidity is revaluing other currencies and driving up asset prices worldwide, inducing systemic instabilities and conjuring the spectre of currency tussles. It has also given rise to legitimate concerns over the value of dollar-denominated assets and the consequent impact on foreign creditors in conjunction with current and future US fiscal consolidation. Before long, the US will be faced with the unpleasant reality of further eroding confidence in the dollar as the primary reserve currency. Thus QE as currently framed will serve neither the US nor the rest of the world well.

On to imbalance targeting. The whole world should be relieved that the G20 has decided against the idea of setting a numeric cap on current account surplus/ deficit as a percentage of GDP. But I suspect the chapter is not yet closed.

Conceptually, the idea is weird, being a blatently non-market-based measure to effect purportedly market-oriented adjustments. For the idea to have been proposed at all by those usually touting free-market credentials is amusing. At a practical level, some important questions will have to be pondered.

Suppose Country A runs a surplus in aggregate terms that exceeds a certain numerical threshold, say 4% of its GDP. Well, first and foremost, why is the cap set at 4%? Why is it not 5% or for that matter, anything else? While we can perhaps skip the trouble of pulling our hairs over why 4% is such a divine number, some equally or even more difficult questions can hardly be avoided. For example, should Country A then stop exporting altogether? As it is most likely that Country A runs a surplus against a Country B but a deficit against a Country C, is a surplus wrong and a deficit right or the other way around? Should Country A shuffle its current account balances between its trading partners? And how? One partner's fair trade might as well be the height of injustice for another. Or should Countries B and C take the initiative and stop importing from Country A? Should countries be allowed to choose for themselves what to or what not to export or import vis-à-vis a particular trading partner? What if Country A's surplus against Country B is attributable to the latter's unwillingness to sell what it produces to the former or the prohibitive prices it tries to fetch? There is a good chance that at the end of day, these common-sense questions will have to be answered through political, rather than economic decisions, which will be arbitrary and create more distortions than they can ever redress.

It might be argued that currency realignment should be the weapon of choice to effect rebalancing or imbalance targeting. This approach is hardly convincing either. For what if it fails to work? Will it have to continue to revalue or devalue until the surplus or deficit falls within the cap? Remember many countries have experienced robust increases in their surplus or deficits while their currencies are appreciating or depreciating. If the "imbalance" reflects endowments, structural elements or competitiveness differentials based on technology and productivity divergences, it is highly likely that the surplus or deficit will stay unless there are significant and steep changes in exchange rates that are disruptive and damaging. In an eventuality like this, both sides will lose out. There will be no winners.

The only way forward is for countries to work together in a spirit of mutual understanding and accommodation. The process might be messy and takes time. But again, these matters are too important for us to be rushed into ill-considered decisions.

( The author is a Chinese diplomat posted in Singapore. His views in this article are personal. )