World economies rearm for a trade war no one wants

There are growing signs the world economy is rearming. For a trade war no one wants.

The signals can hardly be ignored.

Most obvious just now is the battle over money, officially declared last week the "international currency war" by Brazil's finance minister. It is making the front pages and it is getting out of hand. You can't say I didn't warn you.

Even the International Monetary Fund agrees. "There is clearly the idea beginning to circulate that currencies can be used as a policy weapon," the IMF's Dominique Strauss-Kahn says on the front page of London's Financial Times.

Weapons, wars, barriers and interventions. The language of the battlefield is inescapable.

It was Japan that launched the latest skirmish this week, not only dropping its interest rates to absolute zero, but also stockpiling its powder magazine with more than $60 billion US to print yen. As you might expect, that drove the yen down. But only for a while.

Next it was the turn of the United States let slip the dogs of (trade) war.

U.S. central bank chair Ben Bernanke rolled out the guns with a — gasp — veiled reference to quantitative easing. (For a nice definition, check out the first paragraph of this Progressive Economics blog.)

In the diplomatic mum-show of global financial warfare, where there is no such thing as an off-hand comment, Bernanke's words meant the United States was threatening to print money too, debasing its own currency.

The yen went back up and the dollar went down. But as both the yen and dollar battled for last place, something else had to rise. Gold began to soar again. Other commodities did the same. So did stocks. Currencies that had not been debased lately began to rise. Brazil's currency hit a two-year high. The euro went to its highest level since February as traders dumped yen and dollars.

Jean-Claude Trichet, the head of the European Central Bank, pondered whether to launch a counterstroke.  And as the Canadian dollar headed for 99 cents, our own finance minister, Jim Flaherty, warned that Canada's economy could suffer collateral damage.

Tit for tat

It all sounds like a silly game, and although my position is that it's better to laugh than cry, this is serious stuff that could come back to bite us all.

The fight over currencies is making politicians very angry and very frustrated. It could lead them to do something very foolish. As the U.S. House of Representatives did last week.

The American lower house passed a bill saying that, in a tit-for-tat gesture, the U.S. would apply a tariff on Chinese goods to make up for the advantage China gets from having an artificially low yuan.

China immediately responded by shaking its diplomatic fist and threatening tat for tit.

An artificially low currency is indistinguishable in effect from a tariff barrier. A currency war is a trade war.

It reminds me of the joke about the child making excuses for a fight between siblings: "It all started when he hit me back."

And this is exactly how wars of all kinds start. Little spats turn into big ones. As I've said in the past, even the word "protectionism" implies it is always the other guy's fault.

The thing that was driven home by the U.S. bill is that currency wars and trade wars are the same thing. An artificially low currency is indistinguishable in effect from a tariff barrier. A currency war is a trade war.

Nobody wants a trade war, everyone knows it is a bad thing. But no one can make it stop. In that way, trade wars are like real wars, where politicians and diplomats, in a fog of reactive decisions, may have a vague idea where they are heading but somehow assume it will never go quite that far.

Paradox of thrift

Similar to a battle for land, the current war is for a larger slice of a limited piece of terrain. And that terrain is world demand for goods and services.

In good times, demand, unlike land, is constantly growing so everyone can have an increasing share.

The problem now is that demand is drying up in the rich world. And countries are desperately trying to outmanoeuvre their opponents, coming to blows over what business remains. Now that stimulus programs have ended, countries are not borrowing and spending as much as they were.

Neither are corporations. According to the New York Times this week, cheap money is not leading companies to expand and invest in new jobs, but to hoard, or buy existing assets.

Just like governments and corporations, the people who do have jobs are cutting back on borrowing and spending.

To make themselves secure, countries, corporations and ordinary people are saving for that rainy day.

We are witnessing a living, breathing example of what economist John Maynard Keynes called the paradox of thrift. Everyone saves, and as demand declines, everyone gets poorer.

And as each country tries to protect its own citizens' jobs in an effort to hang on to political power, the world is slowly and steadily tumbling into a paradox war that benefits no one and that nobody really wants.