NEW YORK Global policymakers clashed over exchange rates on Wednesday as Western leaders warned China and other emerging markets that simultaneous efforts to weaken their currencies could derail economic recovery.
Treasury Secretary Timothy Geithner said countries with large trade surpluses must let their currencies rise lest they trigger a devastating round of competitive devaluations.
"When large economies with undervalued exchange rates act to keep the currency from appreciating, that encourages other countries to do the same," Geithner said Wednesday ahead of the weekend's semi-annual international Monetary Fund meeting.
Officials around the world fear such a "race to the bottom" will trigger trade tariffs and other measures that damage global economic growth.
Using exchange rates "as a policy weapon" to undercut other economies and boost a country's own exporters "would represent a very serious risk to the global recovery," IMF Managing Director Dominique Strauss-Kahn was quoted as saying in Wednesday's edition of the Financial Times.
But China, which the West accuses of keeping the yuan artificially weak to promote exports, has rebuffed such calls. On Wednesday, Premier Wen Jiabao told the European Union to stop piling pressure on Beijing to revalue the yuan, saying a rapid exchange rate shift could unleash disastrous social turmoil in China.
"Many of our exporting companies would have to close down, migrant workers would have to return to their villages," Wen said during a visit to Brussels. "If China saw social and economic turbulence, then it would be a disaster for the world."
RACE TO THE BOTTOM
The expectation that the Federal Reserve will expand the U.S. money supply again, lowering short term U.S. Treasury yields even further, has weighed on the U.S. dollar pushing the euro, yen and other emerging market currencies higher in recent months forcing some governments to take action.
The global exchange rate system and the issue of rebalancing world economic growth will likely be at the top of the agenda at the IMF meeting this weekend and at Friday's gathering of finance leaders from the Group of 20 economies.
Canadian Finance Minister Jim Flaherty said on Wednesday that officials would discuss currency intervention and inflexible exchange rates.
Despite disagreement among governments, IMF chief economist Olivier Blanchard said he was "optimistic" about a solution. "We are just at the beginning of the process, so it's much too early to declare it a failure."
Others, however, are less sure.
Brendan Brown, economist at Mitsubishi UFJ Securities International, said the IMF, which has the United States as its biggest stakeholder, would not try to prevent further U.S. monetary easing or a weaker dollar.
"That Washington institution has failed in its central mission to prevent currency war," he wrote in a report.
The U.S. dollar tumbled to an 8-1/2-month low against major currencies Wednesday in anticipation of more Federal Reserve monetary easing, pushing the yen to a fresh 15-year high.
The strong yen forced Japan to sell it in currency markets last month, its first intervention since 2004, and several emerging markets have followed suit.
Brazil fired the latest shot this week in what its finance minister dubbed an "international currency war," doubling a tax on foreign investors buying local bonds to 4.0 percent to curb its strong currency.
Some economists assigned blame for the latest flare up on exchange rates to developed countries, notably the Fed's loose monetary policy, which they claim has forced countries such as Japan and Brazil to defend their exporters.
"It's doing nothing for the American economy, but it's causing chaos over the rest of the world. It's a very strange policy that they are pursuing," Nobel economics laureate Joseph Stiglitz said of U.S. policy.
The IMF said Wednesday that emerging economies were set to grow nearly three times as fast than rich nations next year, with China the main engine of growth.
Faster economic growth in developing countries than in developed countries accounts for the natural appreciation pressure on their currencies, particularly compared to the dollar, yen and euro, many economists argued.
"There is a sort of currency war going on about who can depreciate his currency fastest. But emerging currencies are appreciating because their economies are doing better," said Jonathan Xiong, director of global asset allocation at Mellon Capital Management in San Francisco.
But emerging market leaders say the massive cash flows from investors looking for higher returns in developing economies have pushed up their currencies and damaged exports at a time when developed economies also want weaker currencies to stoke growth at home.
South Korea warned investors it might impose further forward trading limits while India and Thailand said they were looking at steps to control speculative flows.
"It's natural in that context for them to say -- we can't just let our exchange rates appreciate and destroy our exports," Stiglitz told reporters in New York this week.
Stemming appreciation won't be easy, though, as investors are bracing for the Fed to announce more easing at its next policy meeting in November. Chicago Fed President Charles Evans was quoted as saying the Fed should do "much more" to boost growth in the face of high unemployment.
In a surprise move this week, Japan pushed interest rates back to zero and pledged to pump more funds into an economy struggling to compete with a strong currency.
The Bank of England meets Thursday, and economists expect at least one official to favor pumping cash into the economy, a scenario that would weaken the pound.
(Reporting by Reuters bureaus around the world; editing by Clive McKeef)