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.
