Why currencies aren't the issue

As G20 finance ministers prepare for meetings in Seoul starting Friday, economists have been assessing the odds of a global currency war.

In a commentary Tuesday, European banking giant BNP Paribas took the threat seriously enough to try to reassure markets that countries would unite to avoid currency jockeying.

"The chance of an agreement has increased as the International Monetary Fund uses its influence to convince G20 participants that an agreement is a must," it said.

But Perry Sadorsky, associate economics professor at York University's business school in Toronto, said the rhetoric about currency wars is a distraction from the real threat.

"Competitive devaluations of national currencies are a reaction to a more pressing problem," Sadorsky told CBC News.

And that is how to get the global trade in goods, services, savings and investment back in balance.

Japan, Brazil and Thailand recently have moved to push down the value of their currencies in a move to protect exports. South Korea, the Philippines, Malaysia and India are thinking about it.

The U.S. dollar has mostly weakened since its high in June amid speculation the country's Federal Reserve will embark Nov. 3 on a program of buying government debt to push more money out to commercial banks in order to encourage them to lower rates and increase lending to consumers and businesses.

'Currency wars' misleading term

Still, Sadorsky said, "currency wars" is probably not the best term to use, "because it sounds like there's something inherently evil going on in the currency markets, and that's not at all the case."

"What we're seeing in the currency action that some countries are pursuing ... is more or less a reaction to a bigger problem."

For example, he said, China, Japan and the U.S. are all tied together in a trade and investment relationship that is out of balance.

Keeping their currencies low has given China and Japan the large U.S. consumer market they need for their goods, American consumers the low-priced goods they want, and American multinationals a way to outsource, using cheap Chinese labour.

Those involved "are happy with that arrangement," Sadorsky said, "but recently we found out that the U.S. government and some other industries are not so happy about that."

U.S. manufacturers contend that the Chinese yuan is undervalued by as much as 40 per cent, giving Chinese exports an unfair advantage.

But the Americans have also benefited. China's currency peg has provided it with foreign exchange earnings that have allowed it to bankroll the swelling U.S. budget deficit — which, in the fiscal year that ended in September, reached $1.3 trillion US.

"That's a lot of money that's going to be financed," Sadorsky said. "China is probably going to buy 40 or 50 per cent of that debt."

And it will buy that debt despite returns of a fraction of a per cent, in what ends up being, in effect, a subsidy for U.S. efforts to stimulate the American economy.

"China does that to ensure that the American economy continues to operate, because they're making all these goods, and they need to keep the U.S. market in a buying mood, to buy what's coming out of China," Sadorsky said.

"China's just taking advantage of the business opportunity."

Sadorsky doesn't see that creditor relationship changing anytime soon.

In 20 years, the trade imbalance among China, Japan and the US has become more engrained, to the point where China now holds $2.65 trillion in currency reserves, two-thirds of which is U.S. dollars.

"China by no means can just let go of all their U.S. dollars. They'd have to find someone who wants to take it off their hands," Sadorsky said. "And since they're such a large player, there's really no other country or organization that would likely do that."

China can't yet turn to domestic market

And China can't, at least yet, turn to its domestic market to buy its massive output of goods.

"China needs to develop a larger middle class … but they're a long way from doing that," Sadorsky said.

Economists worry about large imbalances, fearing that when those imbalances do come back into alignment, the correction will be so sharp it weakens economies around the world.

The answer, Sadorsky said, is for the U.S. to balance it budget and reduce its imports of cheap goods, something he can't see happening in the near future.

"I think the G20 is going to get completely distracted by [talk of currency wars], which is probably not a good thing, because they need to talk about restructuring the global economy.

"The emerging economies are growing very quickly and the developed economies are, for the most part, not growing very quickly at all, and we really need to talk more about that."