Thursday, November 11, 2010

Of Currency Wars and Free Trade Areas... An outlook into the Future

Many years ago, when I was still in school, I read an article in The Telegraph about a South Asian currency which would be used in the South Asian Free Trade Area (SAFTA) which consisted of countries like India, Pakistan, Nepal, Bhutan, Sri Lanka, Myanmar, Bangladesh etc.

The article went onto to say that the world would be divided into trade unions with single currencies like SAFTA, there would be North American Free Trade Area, South American Free Trade Area, European Union, African Free Trade Area, Asian Free Trade Area etc.. Since the appearance of such an article we have already seen the birth of the European Union with a single currency, but none of the other FTAs have come about.

I have mulled on this topic for years and what little economics I know and what little common sense I have all say the same thing. Eventually, many years down the line, the global economy will have to move into a single currency and a global free trade zone to level the playing field for all countries and corporations will be global in nature. Thomas Friedman in his book "The World is Flat" wrote about how playing golf in Bangalore gave him the feeling that the world is no longer round. As the emerging economies emerge into developed economies and as more super powers emerge to meet the established super powers the playing field is more levelled and the world becomes flatter. Not smaller but flatter. This we have already seen happening after the recent crisis. The tables have turned as USA comes begging to India and Asia-Pac for jobs and work. Where it was once the outsourcer and job creator, it remains the outsourcer but our orders and business is what the job creator is now. The playing field just became flatter.

With the US increasing money supply by $600 Bn, the US$ will depreciate as a result of greater supply leading to an appreciation in other currencies. This is why exporting countries are shouting foul. A depreciated US$ would encourage US exports and discourage other countries exports. Where USA was the business giver it is now the business taker competing with all other countries. The playing field just got flatter.

Obama is making the rounds of Asia-Pac buttering up countries and bagging orders, saying that it is in everyone's interest to help USA succeed and get back on its feet. But is it??

Do I want to see an overpowering, arm-twisting bully get back to power? Do I want to see a President who came to beg and still threatened and bullied a countries' government? Do I want to see it support unjust causes and start wars so as to control oil?? Do I want to see it support Pakistan to maintain Britain's old rule of 'Divide & Conquer' such that a united India-Pak is not able to overtake other countries to lead the world?

Why do you think Obama wants China to appreciate it currency? Such that Chinese exports decrease and USA is able to export more, but the Chinese are no fools as they pegged the Yuan to the US$.

Right now all governments across the world are thinking in one way, a single international currency. US$ being the international currency needs to be strong. But does it still have to be the currency of choice?? We have emerged from a bitter recession into a new playing field with new rules and new ideologies. Why not change the currency order?

Allowing US$ to become the currency of choice at Breton Woods was probably the biggest mistake in the first place. It propelled USA to the top and valued the currencies of each country against something whose intrinsic value itself kept changing (How foolish can our economists get!!).

Mint periodical in India reported that the world is now going to move to a new currency order and the next step is to have multiple international currencies. Partly that is true. We will definitely have to move into a new currency order but numerous international currencies?? That is the wrong move. It will just increase competition and make matters worse. Either we have a stable element like Gold as the base for currencies (which is not going to happen because of its rigidities), or we find a way to have less number of currencies in the international market. Valuing currencies against SDR (Special Drawing Rights of the IMF) is also foolish because of political reasons. Whichever country is the strongest will obviously control the IMF.

Analysts doubt if the Euro will exist in the next decade. I say that there will be more currencies like the Euro forming in the next decade or two. Members of the European Union are obviously enjoying many advantages of a free trade area and a single currency. It makes lives easier (of course there are disadvantages too). But the EU is still young. We haven't ironed out the irks of such a system. After the recent Greek and Spain crises the rules of the EU will undergo a change and it will become more stable. After all it is imperfection that ultimately teaches one how to become perfect. In the next 2 decades, I think that the EU will go onto become a single political union. Looking through history we see it as a trend: from being divided and independent, the world is becoming united and inter-dependent and the scale of the recent crisis proves it so.

The Forex market will continue to be volatile and there will continue to be currency wars as the players adjust to each other: forming new agreements, MoUs, cartels and better understand the new rules of the game.

The last group summit committed to reduce currency wars and bring forth more stable currencies, but none of the countries who promised that have done much to show their solidarity to such a commitment. Each country is like an individual, it has to see itself survive, and grab the best for itself, as each country struggles to get back to its pre-recession place, it has to bring forth an extremely competitive front. No country is going to accept less just so other countries can do better, who knows by helping the other country gain now, the other country might snag its (helper country) place later.

As the currency wars get bitter, either our enlightened world leaders will get miffed and we'll enter a new world war as Nostradamus predicted, or a single leader will emerge to take USA's place (unlikely), or the number of currencies will reduce as new FTAs emerge.

I bank on the last.

For the post linked to this please visit:

-> SJ

Currency Wars -> Where each currency tries to be as less valued as compared to other currencies. As each currency tries to be less valued compared to each other we see extreme volatility and unpredictability in the Forex market.

Free Trade Areas -> Groups of countries who have entered into an agreement to trade free of cost (no customs or other duties) between each other. Example: European Union

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