World Bank blames U.S. for unruly capital flows

TOKYO/ PALO ALTO, California (Reuters) - Surging capital inflows threaten Asia’s economic stability, the World Bank warned on Tuesday, a day after Treasury Secretary Timothy Geithner sought to draw the venom from a global row over currencies by vowing not to devalue the dollar.

A bank employee counts U.S. hundred dollar bills at Kasikornbank in Bangkok October 12, 2010. REUTERS/Sukree Sukplang

The World Bank buttressed the argument made by China and others that U.S. policies are sending a wave of cash flowing into higher-yielding emerging markets, undermining their export competitiveness and pumping up inflation and asset bubbles.

“We are seeing an effort by developing East Asia to deal with the large amounts of liquidity driven in very large part by the monetary policy easing in the United States,” Vikram Nehru, the bank’s chief economist for Asia-Pacific, told reporters in Tokyo.

Nehru, presenting a semi-annual report, urged policymakers to learn the lessons of the 1997/98 Asian financial crisis, when an influx of footloose global capital inflated property and equity prices, only for them to collapse when the money flows reversed.

“The authorities in East Asia need to take adequate precautions to ensure that they do not repeat the same mistake twice in slightly over a decade,” the report said.

While capital controls were not very effective in controlling long-term investment flows, Asian countries had an array of instruments to deal with rising inflows, the World Bank said.

“If this liquidity abundance is sustained and increases, I think they are going have to take further action,” Nehru said.

Thailand introduced a withholding tax on foreign purchases of government bonds last week, and Brazil on Monday increased an existing tax on foreign bond buyers to 6 percent from 4 percent.

Foreign investors in Brazil will also have to pay more tax to trade currency derivatives, blamed in part for driving up the real, the country’s currency, to a two-year high.

“Our objective is to reduce foreign investment into Brazil,” Finance Minister Guido Mantega told reporters in Sao Paulo.

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Strains over the constellation of exchange rates needed to put global growth on a more solid, sustainable footing are likely to dominate a meeting of finance ministers of the Group of 20 major economies in South Korea starting on Friday.

The dispute boils down essentially to the exchange rate of the yuan, also known as the renminbi.

The United States, supported by most economists, believes Beijing is unfairly holding the yuan down to give its exporters an advantage in global markets.

This is causing a broader misalignment of global currencies, Washington contends, because other developing countries are reluctant to lose competitiveness versus China by permitting their own currencies to appreciate in isolation.

Speaking in Palo Alto, California, Geithner said he believed China would continue to let the yuan rise to aid the rebalancing of its economy away from exports and toward domestic growth.

“You can’t know how far it should go. What you know now is that it’s significantly undervalued, which I think they acknowledge, and it’s better for them, and of course very important for us, that it move. And I think it’s going to continue to move,” Geithner said.

China would endorse that assessment. The disagreement arises over the pace of adjustment.

China says a spike in the yuan would drive many exporters to the wall, destroying millions of jobs, but would do nothing to address what it sees as America’s deteriorating competitiveness and shortfall in savings.

“We must try to minimize any possible negative impact in further exchange rate reform,” a Chinese central bank spokesman said in remarks reported on Tuesday.

“We must make sure that the currency movements are controllable and avoid any possibility of over-adjustment of the yuan exchange rate driven by market forces,” he told the People’s Daily, the mouthpiece of the ruling Communist Party.

True to its word, China let the yuan drift slightly lower on Tuesday for the second day in a row following a relatively brisk 2.5 percent rise against the dollar since the end of August.


China’s big fear is that Washington, having largely exhausted fiscal and monetary stimulus, is resorting to benign neglect of the dollar to galvanize its economy as part of President Barack Obama’s drive to double U.S. exports within five years.

Geithner flatly rejected this charge.

“It is very important for people to understand that the United States of America and no country around the world can devalue its way to prosperity, to (be) competitive,” he said. “It is not a viable, feasible strategy and we will not engage in it.”

But the treasury chief said the United States needed to “work hard to preserve confidence in the strong dollar” -- his first utterance of the mantra “strong dollar” since February -- by maintaining growth and restoring budget discipline.

Geithner said he had delayed a report due last Friday into whether Beijing manipulates the value of the yuan to win time to drum up support within the G20 for “improvements” in the currency policies of China and other emerging economies.

This week’s G20 finance ministers’ meeting in Gyeongju precedes a summit of the group in Seoul on November 11-12.

Canadian Finance Minister Jim Flaherty said he hoped the meetings would lead to increased currency cooperation.

“This is important so that we avoid the kinds of retaliatory actions that nations can take where they feel that they are aggrieved by the policies of particular countries,” he told reporters in Ottawa.

Investors are alert to the risk of a descent into tit-for-tat protectionism, but, for now at least, many are confident that policymakers will succeed in averting conflict.

“We expect international portfolio flows to continue to create rising tension on asset markets over the next several months, but we do not believe we are as yet at the brink of ‘currency wars’,” Ray Farris and Kasper Bartholdy, foreign exchange strategists at Credit Suisse in London, said in a note.

Writing by Alan Wheatley in Beijing; Editing by Neil Fullick