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IMF leaves question unresolved: Can world avert harmful 'currency war'?

The International Monetary Fund gathering ended with nations going their own way on exchange rates. One reason: the difficult relationship between the US and China.

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The problem is, it doesn't work if everyone tries such a policy at once. "All sorts of efforts are either being announced or contemplated to resist currency appreciation from India to Korea to Taiwan and now Brazil," economist David Rosenberg of the Toronto investment firm Gluskin Sheff wrote earlier this week.

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Money has been flowing into emerging-market nations, helping to put upward pressure on their currencies, because their economies have been stronger than the US or Europe.

One risk is that beggar-thy-neighbor currency policies will be coupled with an escalation of tariffs and other protectionist measures – all of which could put a squeeze on world trade and growth.

Nations that try to avoid the fray can be punished as well.

This week the euro soared relative to the US dollar, in part on expectations of a more expansionary (inflationary) monetary policy from the US Federal Reserve. The strengthening euro, while in one sense a vote of market confidence, could harm European exports during an already weak economic recovery.

Trade imbalance needs correcting

Many economists agree that the pattern of imbalanced trade – with the US importing much more than it exports while nations like China seek to fuel their growth through exports – needs to be corrected.

Some policy experts argue that now is the time for the US and others to push that question, through pressure on China.

"For the recovery to be sustainable there must also be a change in the pattern of global growth," US Treasury Secretary Tim Geithner said in a statement at the IMF meeting Saturday. "It is critical to see more progress by the major emerging economies to more flexible, more market-oriented exchange rate management."

The get-tough approach has critics as well as supporters.

Stephen Roach, an economist who represents Morgan Stanley in the investment firm's Asian operations, warns that moves such as the currency legislation passed by the House could backfire.

"At best, it is a circuitous solution that would address only one of the many pressures shaping the imbalances," he said in a written comment last week. "At worst, it would lead to a trade war, or risk jeopardizing China’s understandable focus on financial and economic stability."

All this leaves a delicate task ahead for global finance ministers and the IMF. In the group's new outlook report on the world economy, though, it warned that rebalancing the world economy is a matter of necessity. That's because consumers in the US can't afford as many imports as they could before the financial crisis.