Trading down

Currency wars worsen risk of trade insurgencies

The risk of trade insurgencies could be on the rise. Weak growth in cross-border exchanges of goods and services last year won't get much better in 2013, according to a new report from the WTO. With Japan the latest big economy to deploy monetary policy to weaken its currency, the temptation to respond with trade barriers can only increase.

The World Trade Organization is justifiably concerned about the two per cent growth it tallied in 2012 and the 3.3 per cent it projects for 2013. The average from 1990 to 2008 was six per cent. Worse, WTO Director General Pascal Lamy said he thinks the threat of protectionism could be higher now than at any point since the crisis began, largely because other economic growth initiatives haven't much worked.

For over five years, central banks around the world have sought to boost domestic outputs by devaluing currencies. Japan's new stimulus initiatives are explicitly designed to weaken the yen, which has declined against the dollar from below 80 in November to almost 100 now. As Lamy noted, though, the more immediate impact will be on capital flows not trade.

Fears have nevertheless been steadily building. Two years ago, Brazil's finance minister warned of a global trade war caused by the currency effects of the Federal Reserve's large purchases of government debt. Poland softened its recession by repositioning the zloty against the euro. Its trade deficit subsequently shrank by 75 per cent from 2008 to 2009. The Bank of England and the ECB also seem committed to further bond buying.

Countries that weaken currencies using monetary policy adversely affect economic activity elsewhere. If growth in rich countries remains weak, as is forecast, then direct protectionist acts like retaliating against the currency depreciation of trading partners are a logical next step.

A full-blown tariff like the US Smoot-Hawley Act of 1930 is unlikely. For one thing, it would run roughshod over WTO principles. However, erecting focused new barriers against particular imports that have benefited from currency depreciation like, for example, tires or solar panels, isn't far-fetched. Only the WTO's prolonged administrative process can block such actions. Global leaders may no longer have the willpower to stop themselves.