Last refuge against currency current

STATES accounting for two-thirds of the global economy are either holding down their exchange rates or steering currencies lower in an attempt to shift problems elsewhere. Nothing like this has been seen since the 1930s.

''We live in an amazing world. Everybody has big budget deficits and big easy money but somehow the world as a whole cannot fully employ itself,'' said former Federal Reserve chairman Paul Volcker in Chris Whalen's new book, Inflated: How Money and Debt Built the American Dream. ''We are no longer talking about a single country having a big depression but the entire world.''

The US and Britain are debasing coinage to alleviate the pain of debt busts: China is debasing to offload its manufacturing overcapacity on to the rest of the world, though it has a $US20 billion ($A20.8 billion) trade surplus with the US each month.

Premier Wen Jiabao confesses that a 20 per cent rise in the yuan would threaten China's social order. ''I can't imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs,'' he said.

Plead he might, but tempers in Washington are rising. Congress will vote next week on currency reforms intended to make it harder for the Commerce Department to avoid imposing ''remedial tariffs'' on Chinese goods receiving ''benefit'' from a weak currency.

Japan has intervened to stop the strong yen tipping the country into a deflation death spiral, though it too has a trade surplus.

Brazil dived into the markets on Friday to weaken the real. The Swiss have been doing it for months, accumulating reserves equal to 40 per cent of gross domestic product in a forlorn attempt to stem capital flight. They too are battling to stop the world taking their structural surplus. The exception is Germany, which protects its surplus ($US179 billion, or 5.2 per cent of GDP) by means of an undervalued exchange rate within the European Monetary Union. The global game of pass the unemployment parcel has to end somewhere. It ends in Greece, Portugal, Spain, Ireland and the Baltics, and will end in France and Italy too, at least until their democracies object.

It is no mystery why so many states around the world are trying to steal a march on others by debasement. The three pillars of global demand at the height of the credit bubble in 2007 were - by deficits - the US ($US793 billion), Spain ($US126 billion) and Britain ($US87 billion). These have shrunk to $US431 billion, $US75 billion, and $US33 billion respectively as sinners tighten belts in the aftermath of debt bubbles. The Brazils and Indias of the world are replacing some of this half-trillion lost juice, but not all.

East Asia's surplus states seem incapable of compensating for austerity in the West, whether because of the Confucian saving ethic, or the habits of mercantilist practice, or in China's case, the lack of a welfare net.

So we have an early 1930s world where surplus states are hoarding money. A solution of sorts in the Great Depression was for each deficit country to devalue, breaking out of the trap. A variant of this may now occur. If China continues to hold down its currency it will import excess US liquidity, overheat, and lose wage competitiveness. This is the default cure and I believe it is well under way.