As world economies continue to falter, central banks are running out of options and the spectre of protectionism grows, writes Larry Elliott.
In all the comparisons between the Great Recession of the past three years and the Great Depression of the 1930s, one comforting thought for policymakers has been that there has been no return to tit-for-tat protectionism, which saw one country after another impose high tariffs to cut the dole queues.
Yet the commitment of governments this time round to keep markets open was based on the belief that recovery would be swift and sustained. If, as many now suspect, the global economy is stuck in a low-growth, high-unemployment rut, the pressures for protectionism will grow.
The former British chancellor Kenneth Clarke summed up the mood when he said in the Observer that it is hard to be ''sunnily optimistic'' about the West's economic prospects.
Despite a colossal stimulus, the recovery has been shortlived and, by historical standards, feeble. The traditional tools - cutting interest rates and spending more public money - were not enough, so have had to be supplemented by the creation of electronic money. In both the US and Britain, policymakers are canvassing the idea that more quantitative easing will be required, even though they well understand its limitations.
There is the sense of finance ministries and central banks running out of options. They cannot cut interest rates any further; there is strong resistance from both markets and voters to further fiscal stimulus, and so far quantitative easing has had a more discernible effect on asset prices than it has on the real economy.
So what is left? The answer is that countries can try to give themselves an edge by manipulating their currencies, or they can go the whole hog and put up trade barriers.
Brazil's Finance Minister, Guido Mantega, warned that an ''international currency war'' has broken out following the recent moves by Japan, South Korea and Taiwan to intervene directly in the foreign exchange markets. China has long been criticised by other nations, the US in particular, for building up massive trade surpluses by holding down the level of its currency, the renminbi.
The currencies under the most upward pressure are the yen and the euro. Why? Because the Chinese have all but pegged the renminbi to a US dollar that has been weakened by the prospect of more quantitative easing over the coming months.
The question now is whether the commitment to free trade is as deep as it seems. The round of trade liberalisation talks started in Doha almost nine years ago remain in deep freeze. Attempts to conclude the talks have run into the same problem: trade ministers talk like free traders but they act like mercantilists, seeking to extract the maximum amount of concessions for their exporters while giving away as little as possible in terms of access to their own domestic markets.
The approach taken by countries at the WTO talks also governs their thinking when it comes to steering their countries out of trouble. There are plenty of nations extolling the virtues of export-led growth, but very few keen on boosting their domestic demand so that those exports can find willing buyers.
The global imbalances between those countries running trade surpluses and those running trade deficits are almost as pronounced as they were before the crisis, and are getting wider. This is a recipe for tension, especially between Beijing and Washington.
This tension manifested itself last week when the House of Representatives passed a bill that would allow US companies to apply for duties to be put on imports from countries where the government actively weakened the currency - in other words, China.
The Senate will debate its version of the same bill after the mid-term elections next month, but it was interesting that the House bill was passed by a big majority and with considerable bipartisan support.
China responded swiftly and testily to the developments on Capitol Hill. It argued that the move would contravene WTO rules and quite deliberately tweaked its currency lower.
It is not hard to see why Beijing got the hump. It introduced the biggest fiscal stimulus (in relation to GDP) of any country and helped lift the global economy out of its trough. It can only fulfil its domestic policy goal of alleviating poverty if it can shift large numbers of people out of the fields and into the factories, and that requires a cheap currency. It has been financing the US twin deficits.
Unsurprisingly, then, its message to the Americans was clear: ''It is not smart to get on the wrong side of your bank manager, so do not mess with us.''
What happens next depends to a great extent on whether the global economy can make it through the current soft patch.
But imagine that the next three months see the traditional policy tools becoming increasingly ineffective, that the slowdown intensifies and broadens, and that the Democrats get a pasting in the mid-term elections. In those circumstances, a trade war would be entirely feasible.
Guardian News & Media
http://www.smh.com.au/business/spectre-of-international-trade-war-looms-as-recovery-proves-elusive-20101004-164e1.html
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