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How Realignment of Currency Values Helps Reduce Global Economic Imbalances
According to Corden, a shaky global economy in recent times is very important issue shows the extreme imbalance, caused by artificial currency valuations (363). The case of imbalance is due to the imbalance caused between developing countries which produce by export on a massive scale sine they lack the confidence to “consume their production and the resultant savings” (Corden 364). The developed countries seem to be in “post-modern stage of economic evolution” engage in high consumption. This resulted in developing countries building their Foreign Exchange (Forex) reserves while the “developed countries are accumulating the corresponding debt” (Corden 363).
It is important to look at the causes of this imbalance, how the imbalance affects the global economy. It can be seen that the global imbalance arises because of extremely excessive levels of current account surpluses experienced in some countries compared to those that exhibit current account deficits (Onno 113). A typical example is that of America in 2006 when it experienced a current account deficit of about seven percent in its gross domestic product while a country like Japan boasted of a surplus of above fifty percent in its current account (129 ). The global economy faces serious risks as the causes of the imbalances seem to have sustained this phenomenon and allowed it to grow to unimaginable size.
Causes of Global Economy Imbalance
The other cause of the global economy imbalance is sustained flow of capital to places that are in need of huge capitals for their own development from those that boast of financial stability. It is disturbing that the “growth of the rich countries hinges to a very large extent on the sustained flow of capital from others”. These countries happen to be the poor ones who are more than willing to export their capital to the rich countries. Such a scenario denies the poor countries the right and privilege to use their capital. Recent studies indicate that large current account deficit of countries like America affects the global economy through its ability to attract and absorb about 75% of the world surpluses (Onno 118).
How to Achieve Global Economy Imbalance
A consensus is being built in the world on how identify and sustain ways of adjusting the global economy imbalances. One of the ways that is being fronted is the use of exchange rates so as to reduce the imbalances (Onno 120). The assumption is that the reduction in imbalances depends on “a rebalancing of the differential saving and investment behavior” in both those countries with surplus and those with acute deficit. When this is encouraged it might as well reduce the need to rely on the realignment of exchange rates.
Cooper concluded that the deficit in current accounts of the rich countries can only be substantially reduced when a “major real exchange rate depreciation” takes place (16). For example most countries in the world have been affected by the collapse of giant financial institutions in the America and are sure that such a rich country with a deficit in current accounts can collapse if they don’t intervene through Forex market by realigning currencies. The collapse of such countries would leave most countries in the world long-term losers (Mann 132).
All countries in the world would benefit if they take a bold step of intervening through Forex market by realigning the currencies. They would be operating knowing that they are safe of any eminent collapse of any rich economy that they so much depend upon. The threat posed by the global economy imbalances is real as it directly affects the functioning of the international monetary system. Therefore a successful correction mechanism requires not just realignment in forex exchange but also fiscal and currency policies. This is the case because no country in the world can boast of being able to give any workable sustainable solution. This realization is seen in the approach the IMF is using to try and curb the increase in the imbalances. They have made known to all nations that it is a shared collective responsibility among all nations that will help to correct the present time imbalances (Mann 160).
IMF employs what is referred to as Medium Term Strategy (MTS) to help correct the imbalances. It goes further to suggest the following; The rich countries with deficit current accounts should raise their national savings e.g US.Other countries should have sustained structural reforms as this will foster growth and increase the domestic demand.To ensure that a flexible system for exchange rate is in place in those countries with surplus by realignment and installing a monitoring programme.
This simply that IMF is encouraging a consolidated process that which allows exchange rate flexibility. It is true that there exists a system which causes artificial undervaluing of currencies while at the same time allowing increased circulation of major currencies like dollar and euro globally. This gives rise to “excessive liquidity in within their national economies”, a situation that causes excessive inflationary pressures globally. Since most commodities are traded on international market in the major currencies, the prices have been seen to soar above the expected safe economic limit (Mann 137).
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Currency realignment would allow all other currencies to be revalued. This would drastically reduce global inflation, a major indicator of the economic imbalances. Gundzik states that global inflation is triggered due to the currency valuation mechanism (13).
The Benefit of Currency Realignment Policy
The realigning of currencies is believed to cause excessive global liquidity in the economies of countries in the world. Such a situation will lead to growth of money supply and credit. An example of this was seen in Indian economy in the years 2005-2007 where it is recorded that the “net accretion to the Forex reserves aggregated to excess of USD 50 billions” (Bird and Alex 89).
The increased flow of foreign exchange stimulates the growth of GDP and results in an increased credit flow by the banks. Therefore the monetary policy intervention through liquidity is not just exceptionally to specific countries but rather the rule globally (Bird and Alex 89). This is the main reason as to why most countries have tight monetary policies to help contain inflation.
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However, the future monetary policy adjustments highly depend on the outlook for global inflation and economic growth. The negative consequence of oversupply of liquid cash due to realignment is the likelihood of having fat Forex reserves with no corresponding of individual currency appreciation against major currencies of the world. On the other hand the advantage is that while there is no appreciation, there is also no depreciation which would trigger skyrocketing of commodity prices.
This move of having oversupply of foreign currencies in form of stock market and banks can be harmful to the economy. Suppose the imports shoot up or the investors withdraw their foreign capital then individual currencies would go into a tailspin.
The Missed Point of Bird and Alex 89
There are wrong global assumptions that national economic boundaries do not matter. Even though this argument has been fronted by the “economists, analysts and by the media” it should be noted that drives the theory of globalization in purely the performance of national economies. This are credited with shaping the global economy. We cannot have a borderless world. The realignment of currencies is not creating no boundary situation rather strengthening these boundaries through harmony in diversity (Bird and Alex 90).
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The ability to clearly draw a roadmap out of the global imbalance require a clear understanding of the main causes of current global imbalance. It is believed that all this started after World War II with the formation of Bretton Woods which came with the idea of fixed exchange rates between other countries and the dollar, “restrictions on capital flows and the creation of a multilateral organization to oversee financial development” (Bird and Alex 90). This body was called the International Monetary Fund.
The Bretton Woods permitted restricted fluctuation in exchange rate causing the misalignment in the currencies used all over the world. The key currency here was the dollar which had a guaranteed fixed exchange rate.
The solution of such scenario lies in reduction current account deficit of countries like the US with a similar reduction in the surplus of current account surpluses from the exporting countries. This can only be realized through the “correction in exchange rates of various countries, which are to be revalued against the dollar and euro” (Bird and Alex 93 ). With the assumption that doing this will automatically correct the current account deficit of the rich countries, currency realignment can be floated as the best option to check the global imbalances.
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Even though this remedy has been fronted by many researchers, it ignores the fact that the world is not a village when it comes to culture. It is imperative to consider cultural differences and the dynamics that accompany it when making such an assumption. The theory of currency realignment misses another important point. The experts here fail to look critically at the extant of global imbalance caused by “differential life-styles, value systems and religious beliefs” (Mann 140). This simply means that whether there is currency realignment or not, the global imbalance will still be present and continue to grow.
Global economic imbalances are easy to correct in theory but extremely hard in practice. It is important to remember that things like saving or not saving are deeply rooted in the culture and beliefs of a specific people. Devaluation of major currencies and revaluation of other global small currencies would seem to be able to solve the problem of global imbalances but in reality, this would be disastrous in the long run as it will discourage exports and imports. The truth is that the management of available capital and sound exchange rate mechanisms is the determinant of the stable global economy.