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Michael Pettis

Last week, European Central Bank president Jean-Claude Trichet warned against the further strength of the euro against the US dollar. 
At about the same time, Asian central banks, worried that the failure of the yuan to appreciate against the dollar would cause their economies to lose export competitiveness, intervened heavily in the markets to slow the appreciation of their currencies against the dollar.
Meanwhile, China's press is fulminating against claims that the yuan must be revalued. An article in Xinhua insisted last week that rich countries had 'turned fire on China's currency, blaming it for the financial crisis' and in so doing had shirked their due responsibilities in the global financial turmoil.
What is going on? While the world is united in calls that the United States must raise its savings rate and rein in its trade deficit, the world's central banks are doing everything possible to prevent any of the adjustments taking place against their own economies.
But these are one and the same thing. Overvalued exchange rates are part of the mechanism by which the US must run a trade deficit. An overvalued dollar increases the real value of US household income while effectively taxing the manufacturers in the tradable goods sector. This automatically forces consumption to grow faster than production and helps push America into a trade deficit.
Meanwhile, countries with undervalued currencies have the opposite experience. As the cost of imports is forced artificially high and the producers of tradable goods are subsidised by the undervalued exchange rate, growth in production exceeds growth consumption, leaving these countries with persistent trade surpluses.
Everyone seems to agree that, as part of the necessary global rebalancing, the US will have to reduce its net imports, but everyone also seems to agree just as fervently that any reduction of the US trade deficit should not come at their expense but, rather, at the expense of the rest of the world. It doesn't take a PhD to see the mathematical difficulty.
In fact, there are probably few global discussions in the world today that are more confused than the debate on the currency. There is no question that the US consumes far more than it produces, and there is also no question that any sustainable resolution to the global imbalances will require that the US adjust.
There are several ways that this adjustment must take place, and among them a continued depreciation in the dollar against its trading partners will be an important factor. But for the dollar to depreciate, other currencies must by definition appreciate against the dollar.
But how? Japan and Europe argue that their currencies are already expensive and any further appreciation will force distress on to their tradable goods sectors and cause sharp rises in unemployment.
Developing Asia has built its growth model of the past 30 years around a series of policies, including undervalued currencies, aimed at boosting production much faster than domestic consumption, and to reverse this model now would be extremely painful. Other developing countries are determined to increase exports, especially as the financing of current account deficits has become all but impossible.
Like in the 1930s, every country wants to devalue its currency relative to the currencies of its trading partners to boost domestic employment and take a larger share of foreign demand. But, as we learned in the 1930s, it is by definition impossible for everyone to improve export competitiveness by devaluing.
So, how will the disagreements be resolved? Almost certainly by an increase in trade conflicts. What many of the global participants have probably forgotten is that in a world of contracting demand, it is countries that control net demand that are in the strongest position to determine the outcome of a fight over trade. 
If the dollar is not allowed to depreciate in an orderly way against the currencies of all of its trading partners, trade tensions have no way to go but up.
Michael Pettis is a professor of finance at the Guanghua School of Management at Peking University and a senior associate at Carnegie Endowment for International Peace



Can't we all just depreciate our monies together?