Hamish McRae: Will there be a currency war? Maybe not, but countries are being selfish

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The Independent Online

It is World Bank and International Monetary Fund time again – the weekend when the finance ministers and central bankers of the world gather at the twin institutions' headquarters in Washington for a string of meetings.

But it is more than that. It is a moment to pause and think about the direction of the world economy. It is a moment for the grandees, and that is what they are paid to do. But it is also a moment for the rest of us. There is a lot of fear around and it is as good a time as any to ponder how justified that really is.

Start with the threat of a currency war. The phrase is "competitive devaluation", when countries race against each other to push down the value of their currencies in the hope that their exporters can gather a larger share of world markets, and that importers will find it harder to sell to them. A number of countries stand accused. At the top of the list comes China. It has maintained a currency peg with the US dollar which, though eased from time to time, in general under-prices Chinese exports. You can argue about the extent of the revaluation needed and you can criticise US fiscal and monetary policy for boosting consumer demand and sucking in so many cheap imports. But the fact that China has such a huge trade surplus with the US suggests that there is some undervaluation. The US Congress, which has long had a protectionist streak, is currently threatening retaliation if China does not permit a further revaluation.

Now, however, China has found the US joining it in the dock. The charge is that America too is trying to depress its currency, in this case by the US version of quantitative easing, with the Federal Reserve flooding the country with dollars, a large portion of which then flow abroad. As they move across the exchanges they tend to depress the value of the currency. Concern about this shows up in a number of ways, the most obvious of which is the surge in the price of gold. This is now in dollar terms at an all-time high. Funk money goes into gold.

You could argue that we are doing it too. Remember the sense of relief here that we are not in the eurozone: so, unlike Ireland, we have been able to devalue by something close to 20 per cent. One of the arguments in favour of our own quantitative easing programme is that it helps hold down sterling. This happens directly in so far as the money that is "printed" goes abroad across the exchanges, but also indirectly because it helps hold down long-term interest rates. Whenever there are rumours of a new bout of "QE", sterling falls.

But not every country can devalue, for that is a mathematical impossibility. At the moment, the principal custodian of monetary orthodoxy is the European Central Bank, which seems to be preparing to end its own version of QE. But as has been widely noted, the eurozone has problems of its own.

So is there really a currency war starting? Take the view of Dominique Strauss-Kahn, the managing director of the IMF. He said last week that China must allow the yuan to appreciate to reduce the country's reliance on foreign export markets, adding that it has been undervalued for years. He also attacked the general lack of international co-operation.

"The willingness of the countries to work together, which was very strong at the climax of the financial crisis is not as strong today," he said. "Currency war might be too strong, but the fact the countries want to find domestic solutions to a global problem is really a threat to the recovery."

He made a further point: that the emerging economies were seeking greater representation at the IMF but that brought greater responsibilities too. That seems to me to be the other great theme of international finance at the moment: the passing of the baton of power. For the moment, the US remains the world's largest economy and it will do for another 15 or so years. But there are various projections of how swiftly China will overtake it and I have put those from the Goldman Sachs "Brics" model in the graph. This first one shows the top 10 countries now; the second in 2020. The figures are shown in constant 2007 dollars because the model itself adjusts for some revaluation of the yuan against the dollar over time (and by the way, this particular run of the model has not taken into account the recent fall in sterling vis-à-vis the euro).

As you can see, China has already passed Japan as the second-largest economy, and while in 2020 it will still, on these calculations, be smaller than the US, it passes it some time around 2027. India, again as you can see, is heading up the league table. By 2020 and by 2030 it will have passed Japan and come into the number-three position.

You don't need to accept the detail to grasp the big point. In another decade, and certainly within two, economic power will be with the emerging nations, not the old, developed world. So the question will be: how will these new powers run the show?

To answer that, stand back from the position of the world economy now and ask another question: how well have these new powers come through the downturn?

In practical terms they have come through much better than the rest of us. Both China and India have grown every single quarter. Looked at overall there was no recession in the emerging world. That better performance was not entirely the result of undervalued currencies, though there may be something there. It was the result of having stronger banking systems, of having lower debts, of keeping competitive in world markets. Frankly, they have done better than we have.

So, in weighing up the fears for the recovery, my instinct is to think that growth will continue, driven by these new powers, even if the developed world experiences some sort of double dip. Like many people, there are aspects of Chinese policy I feel worried about, and I share the concerns about lack of international co-operation. But I think we have little right to preach.

Pensioners face nasty surprise as Government seeks to link payments to new index

Next week will see some nasty inflation figures. No, I have not been slipped a preview in a brown envelope – it is just that the latest producer price index (our old wholesale price index) out last week was nasty at 4.4 per cent, and the trend of the two consumer indices has also been nasty in recent months.

This matters because the September figures are the most important in the year – they set government payments for pensions and other inflation-linked payouts for the next 12 months. So a high number in September increases public spending. Some revenues are pushed up by inflation, VAT for one, but as private sector wage rises have been weak, there is little uplift there.

A further issue is that the Government wants to link pensions and other benefits to the new consumer price index, the harmonised index that is supposed to reflect price increases in an EU-wideway, rather that the longstanding retail price index. They differ in two main ways: the CPI is a geometric meanrather than an arithmetic mean, which has the effect of giving a somewhat lower figure for any given set of input data. To allow for that, the centre point of the inflation target range was cut from 2.5 per cent to 2 per cent when the Bank of England, against its wishes, was forced to shift its inflation target by Gordon Brown from a modified version of the RPI to the CPI.

The other is that the CPI makes little allowance for housing costs, I am told because EU statisticians cannot agree on the best way to do so, though that may be unfair. By contrast, mortgage payments and rents are in the RPI. You can see why the Government wants to move to the CPI: it cuts public spending. But the astounding thing is that such a move has been so meekly accepted. The pension industry is growling a bit but largely because the change in the government measure is confusing for the private sector. But for pensioners, if the proposals go through, it is one more blow.

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