By Steven K. Beckner - U.S. Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke are likely to get an earful about "hot money" and the United States' alleged culpability for it in the next couple of days as Group of 20 finance ministers and central bankers meet to confront international economic and financial challenges.
But from the standpoint of Geithner and Bernanke, "hot money" flows into other countries and their inflationary implications are not a reflection of U.S. monetary or other policies so much as they are an indictment of the rigid exchange rate policies of China and other U.S. trading partners.
In sharp contrast to previous G20 meetings, inflation is bound to be a major topic, though it's not on the agenda per se. But while inflation fears are mounting in emerging markets and even in parts of Europe, they remain minimal in the U.S., making for tension among the major G20 members.
More officially, G20 policymakers will focus once again on how to reduce global trade imbalances, and they will be seeking to flesh out an agreement to tackle that perennial problem which was reached last November in Seoul by their leaders. There will also be further discussions about how to strengthen and coordinate international financial supervision.
Potentially overshadowing all these discussions is the ongoing European sovereign debt crisis, which has been exacerbated in recent days by a disappointing Spanish bond auction. A large new euro-zone bail-out fund, proposed to total 500 billion euros, has been tentatively agreed upon, but its ultimate fate has been cast in doubt by the abrupt resignation of Bundesbank President Axel Weber.
With the departure of Weber, heir apparent to Jean Claude Trichet as the third president of the European Central Bank, German political support for an enlarged, permanent bail-out fund has come into question. And that adds another downside risk to the global economy for G20 policymakers to ponder.
While the G20 are sure to reaffirm their desire to "reduce excessive imbalances," actually achieving that result is apt to remain a will-o-the-wisp given conflicting interest, divergent economic trends and seemingly intractable policy differences.
Most notably, although China last week pegged the yuan/dollar exchange rate at its highest level ever, it continues to limit the amount of appreciation it permits -- much to the annoyance of the United States and other advanced countries.
Exchange rates, indeed, are at the heart of both the hot money and trade imbalance issue, at least as far as U.S. officials are concerned.
The Fed has been accused by China, as well as Brazil and others, of fueling inflationary "hot money" flows into emerging markets. And the host French are expected to push for some new system or process for limiting capital inflows into emerging market countries in Asia and elsewhere.
It has been proposed that the International Monetary Fund, an eager participant in the G20 process, be given additional responsibility for monitoring capital flows and setting guidelines for curbing them if necessary. Once-deplored capital controls are getting a more favorable look as a kind of last resort that the IMF is prepared to countenance in dire circumstances.
"Hot money" is not a new issue. Since the Fed launched its second, $600 billion round of quantitative easing last Nov. 4, charges have been flying at the U.S. central bank.
By holding short-term interest rates near zero and buying hundreds of billions of dollars of assets in an attempt to hold down long-term interest rates and speed the U.S. recovery, it is contended, the Fed is generating yield-seeking capital inflows into more rapidly growing emerging market countries and swelling both asset bubbles and price pressures.
But while inflation has been visibly mounting in Brazil, China and other "emerging market nations" and raising alarms in Europe, Bernanke persisted in calling U.S. inflation "quite low" and inflation expectations "stable" in testimony before the House Budget Committee last week.
Confirming what MNI has been reporting, minutes released Wednesday show that the Fed's policymaking Federal Open Market Committee reevaluated the balance of risks and upgraded its forecast of growth, jobs and inflation at its late January meeting. But the predominant FOMC view remains that unemployment is still much too high and inflation much too low to contemplate tightening monetary policy in the near future.
And from the standpoint of Bernanke and Geithner, former president of the New York Fed, U.S. monetary policy has nothing whatsoever to do with global price pressures. If there's an inflation problem, they argue, it's because China and other countries insist on keeping their exchange rates relatively rigid relative to the dollar -- thereby importing a monetary policy which, while appropriate for the relatively sluggish U.S. economy, is not at all appropriate for fast-growing economies like China's.
Instead of trying to rely on interest rates to curb demand and contain inflation, China should allow the "undervalued" yuan to appreciate, Bernanke told the House Budget Committee last week. In short, it should stop tying its wagon to "highly accommodative" Fed policy, he argued.
The U.S. Treasury has made similar arguments -- going so far in the recent semi-annual exchange rate report to Congress to call the yuan "substantially undervalued."
Once again, however, Geithner pulled his punches, declining to brand China a currency "manipulator" in the Treasury's semi-annual foreign exchange report to Congress. The decision is understandable, perhaps. Accusing China of exchange rate manipulation and thereby opening the way for trade retaliation against China may not have been very diplomatic at a time when the U.S. is becoming ever more dependent on Beijing to finance a record federal budget deficit -- expected to exceed $1.5 trillion this year.
A couple of days ahead of the G20 meeting, a senior U.S. Treasury official reiterated the U.S. position, saying, "G20 members need to free up exchange rates to facilitate adjustment. For the global adjustment process to work, all major economies must allow their currencies to adjust in line with market forces or risk imposing excess burdens on others.
"Moreover, with commodity price inflation on the rise, exchange rate appreciation is key tool in many cases to help dampen inflation," the official told reporters in Washington.
"Countries with undervalued currencies should allow their currencies to appreciate," said the official, who again called the yuan "undervalued." Bernanke has made similar comments on a number of occasions.
As the second largest economy in the world, China's currency should "play a larger role in international transactions over time," the official said.
France would like to speed that process along. Its president Nicolas Sarkozy has said the yuan should become a component of the IMF's numeraire The Special Drawing Right or SDR as part of a process of increasing the yuan's role as a reserve and transaction currency.
France would also like to advance the cause of "rebalancing" the world economy.
In their final communique in Seoul, which South Korean President Lee Myung-bak called "historic," G20 leaders agreed to "strengthen multilateral cooperation to promote external sustainability and pursue the full range of policies conducive to reducing excessive imbalances and maintaining current account imbalances at sustainable levels."
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