Brazil's ''Currency War'' Worries

Global finance ministers failed to agree on a solution to ongoing currency disputes over the weekend in a row that could turn ugly. Brazilian Finance Minister Guido Mantega drew media attention to what he calls an “international currency war” when he announced on September 27 that Brazil would take measures to slow the appreciation of the real and curb its volatility. In remarks at the Americas Society and Council of the Americas, he called for exchange-rate coordination in order to avoid a trade war. Both emerging economies and advanced economies struggling to restart growth have begun to enact so-called “beggar-thy-neighbor” interest rate and currency policies, raising the specter of protectionism that could hinder the global economic recovery.

Brazil, the third fastest growing economy in 2010, has criticized the United States and China for their exchange rate policies. Mantega maintains that they’ve hurt Brazilian manufacturing and the export sectors of other emerging economies. As rapidly developing economies such as Brazil’s experience currency appreciation relative to the U.S. dollar and the Chinese yuan, their export sector suffers, he contends. The appreciation stems from a combination of factors including low exchange rates abroad—most notably in China—and dramatic inflows of capital. Higher interest rates and investment opportunities such as Petrobras’ record-setting public offering in September attract foreign capital, which in turn increases demand for the real.

Last week, Brazil unveiled its plan to double taxes on foreigners’ bond investments from 2 to 4 percent in an effort to control currency appreciation. The plan, however, “went off with a whimper,” writes Jonathan Wheatley in the Financial Times’ Beyond BRICS blog. “Investors, in a reversal of the usual procedure, sold on the rumor and bought on the fact.”

Meanwhile, calls for cooler heads on currency policy have gone unheeded. In the run up to November’s G20 summit in Seoul, international finance ministers met in Washington from over the weekend, where overcoming the currency dispute to avert protectionism topped the bill. “World leaders must defuse currency tensions before they worsen to avoid repeating the mistakes of the Great Depression,” warned World Bank head Robert Zoellick. Dominique Strauss-Kahn, his counterpart at the IMF, urged China to take faster steps toward addressing worries about its undervalued currency. Beijing’s Central Bank head said China will take it one step at a time when it comes to shifting its exchange rate, adding: “We will do it in a gradual way rather than shock therapy.” The failure to reach any compromise speaks to tensions between the United States, Asia, and Brazil, causing Canada’s Finance Minister Jim Flaherty to warn that “currency disputes can easily become trade disputes.”

Countries threatened by the external currency devaluations have erected punitive tariff barriers, artificially devalued their currency for a competitive edge, or imposed stricter controls of the flow of capital. This raises the question of what will happen to emerging economies in Latin America as the United States, which has legislation pending that would impose tariffs on Chinese imports, and China clash over exchange rate policies. A World Politics Review piece argues that these moves towards protectionism indicate that “the world’s major economies now appear ready to turn on one another with truly self-destructive vengeance.”

Learn more:

• Access Brazilian Finance Minister Guido Mantega’s presentation at AS/COA on October 12.
• Access the Brazilian Ministry of Finance’s economic outlook evaluations.
• Roubini Emerging Markets Economonitor considers the effects of the currency dispute on Brazil.
• Forbes blog Great Speculations examines the United States-China currency conflict.
• Financial Times chief economic commentator Martin Wolf interviews Special Advisor to the Managing Director of the IMF Min Zhu about currency wars.