This weekend's annual meeting of the International Monetary Fund (IMF) in Washington looks set to become a battleground over the question of currency values, particularly what the United States views as the artificially low rate of the Chinese currency, the yuan.
The seriousness of the situation can be seen in comments by top officials from both the United States and China. U.S. Treasury Secretary Timothy Geithner has called the currency issue the "central existential challenge" facing the world economy.
Speaking at a Washington think tank on October 6, Geithner said Beijing's policy of keeping the yuan low is causing what he called a dangerous dynamic that encourages other countries to do the same.
He was referring to moves by Japan, South Korea, and other industrialized and developing countries to intervene in world markets to try and stop their currencies gaining in value.
A cheap currency makes exports more competitive in price, and makes imports less attractive, thus being key to a more favorable trade balance.
Capital in recent months has been pouring into emerging markets like China, India, and Brazil and away from highly indebted developed economies like Britain and the United States. That has put upward pressure on emerging-market currencies. For example, Brazil's currency, the real, which floats freely on world markets, has appreciated by nearly 40 percent against the dollar since 2009.
Many economists say the same should have happened with China's yuan. But it hasn't, because Beijing keeps a tight hold on its currency, leading the United States and others to complain that China is in essence cheating -- in order to boost its exports. Inspired by the Chinese example, global export powers Japan and South Korea have intervened on world currency markets to keep their currencies low.
EU leaders urged China's Wen Jiabao to do more.
Economists and policymakers around the world worry that if the trend catches on, it could spark global competitive currency devaluations as well as tariff wars, much like happened in the 1930s during the Great Depression.
"The worry is that when growth is scarce, that economies will seek to beggar their neighbors, you know, to get growth at the expense of the other economies, so there is this feeling and worry at the moment," London-based currency analyst Bernard McAlinden of BGC Brokers explains.Navigating A Delicate Balance
On the other side, Chinese Prime Minister Wen Jiabao warned that the currency issue has the potential to throw China -- and by extension the rest of the world -- into chaos.
Wen told a meeting of top EU officials in Brussels on October 6 that if China increased the yuan's value by 20 to 40 percent -- which some critics say would reflect its true level -- then many of the country's factories would have to shut down and Chinese society would be in turmoil.
He urged the European Union not to add its voice to the U.S.-led campaign for a major revaluation of the yuan. He repeated a promise frequently made to allow the currency to appreciate slowly.
During Wen's European trip, some leaders have nudged China to do more. But the EU's monetary affairs commissioner, Ollie Rehn, contented himself with a diplomatic reference to the yuan needing "more flexibility."
The United States, having trodden the diplomatic road to no avail, seems ready for a more robust approach. It wants the IMF to take a higher profile in "rebalancing" the world economy. The IMF was formed in 1945 to work for stable exchange rates and the economic policies that produce them.
Geithner earlier this week offered what amounts to a grand bargain: more influence for emerging economies like Brazil, India, and China at the IMF -- but only if those countries adhere to free-market principles for their currencies. "That's the deal on the table," Geithner said.
Currency analyst McAlinden says there is a logic to this proposition. "What's entailed here is that you need to see the trend that currencies of the indebted developed economies should still be depreciating against the currencies of emerging economies which have creditor status and are resource rich," he said.
Caught in the middle of this crossfire is IMF chief Dominique Strauss-Kahn, He's reportedly not keen to take a radically tougher stance, being aware of the IMF's lack of formal powers to effect change. The United States is the biggest shareholder in the IMF, and China is the sixth-biggest, and so Strauss-Kahn has a delicate path to tread between the two.
But he acknowledged in an interview with the "Financial Times" on October 6 that there's the risk of "currency wars" breaking out if countries use tactics to influence exchange rates in an attempt to boost their exports.
Strauss-Kahn says there's a clear trend developing for governments to view currencies as what he called a weapon of policy.