We don’t normally look to Mervyn King, governor of the Bank of England, as a luminary of the financial world. Not that Mr. King isn’t a clever fellow, but he has a rather unfortunately stodgy image that belies his considerable intellect. However, comments in the bank’s Inflation Report this week make such interesting reading that they deserve examination here.
“There is only one way for the world to go, he is quoted as saying in the Telegraph, “for the pent-up losses caused by the vast debts amassed in the boom to be shared between creditors and debtors. This, he said, meant that “in the world economy between creditors in the East and debtors in the West, and within the euro-area between creditors in the North and debtors in the South.”
The problem is that there are two ways the situation can be resolved; either voluntarily, as surplus countries like China let their currencies appreciate, or violently, in the context of a downturn in the world economy. Unusually for a central banker, he pulled no punches in placing at least some of the blame on China for pegging its currency to the dollar and in the process amassing huge quantities of the currency that it essentially lent back by buying US treasuries, keeping US rates low and stoking the debt buildup around the world.
Under normal terms of trade when a country does well, runs a surplus and enjoys booming exports, its currency appreciates relative to the currency of the countries it is selling to; as the currency appreciates, competitiveness declines, creating a natural balance. This was not allowed to happen with the Chinese yuan, creating the imbalances we have today. But China was not alone in being the target of his criticism.
In the same way, Germany has benefited from its membership of the weak euro, and this has boosted exports in a manner that would never have happened if Germany had retained the deutschmark. The currency would have been much stronger and exports would have been lower as a result. Those funds were recycled internally in loans to poorer, less fiscally disciplined southern European states, countries that are now so uncompetitive and so indebted they are unlikely to ever be able to repay debts.
King is suggesting that creditors such as China and Germany are as much to blame for the current situation as debtors like the US and UK, and that creditors will have to share in the pain with debtors who so far have borne the brunt of the sacrifices by way of austerity measures. China will face further currency appreciation, which will devalue its US debt and reduce its export competitiveness, and Germany will have to absorb losses through rescue schemes and write off sovereign debt held by its banks — if they do not, then a prolonged global recession is the alternative outcome.
In King’s view, the global economy is back on the precipice and it is the world’s creditor nations that are holding the rescue lines.