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David R. Francis

Currency market: Fix the rules. Avoid a trade war.

Currency market adjustments are a major focus of Friday's G-20 meeting of finance ministers and central bankers.

By David R. Francis / October 22, 2010

Finance ministers and central bank governors attend a G20 meeting in Gyeongju, South Korea, Oct. 22. A major focus of the meeting is how to fix the currency market to bring the world economy back into balance.

Ahn Young-joon/Pool/Reuters

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The world needs new rules to keep nations from manipulating their currencies to get an export trade advantage. If rules don't get written, today's escalating trade frictions could heat up into a debilitating trade war.

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That's the concern of some economists looking at the massive balance-of-payments deficit of the United States (heading toward $500 billion this year) and the huge trade surpluses of China. China's surprise quarter-point rise in interest rates Tuesday, which makes its yuan more attractive, could raise its foreign-exchange value. That would please the US. But finance ministers and central bankers of the G-20 group of nations are meeting Friday in South Korea because more adjustment is needed in the currency market to bring the world economy back into balance.

"We desperately need a new Bretton Woods," says Charles McMillion, a Washington consulting economist.

That New Hampshire gathering of the major industrial states as World War II was still raging crafted the postwar international monetary order of fixed currency exchange rates.

When those rates no longer reflected reality, those nations came together again in 1973 to craft the Smithsonian Agreement, which in effect gave the US a small devaluation of the dollar. President Nixon hailed it as "the greatest monetary agreement in the history of the world" (a statement your correspondent missed because, having wandered outside Smithsonian Castle, he got locked out when Nixon suddenly arrived for his press conference.)

Nixon's evaluation didn't prove true. The world's greatest monetary agreement lasted only 14 months. The fixed exchange rate system broke down, giving way to a "floating" system where the price of the dollar and other major currencies was set largely by supply and demand on foreign-exchange markets. The greenback promptly lost 20 percent, which helped rebalance world trade.

The Smithsonian deal created a troubling legacy: Developing countries weren't covered by the currency agreement. Most of them continue to fix their foreign exchange rates by intervening in the market.

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