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Currency war feared if nations move to defend industry

In the second part of our series on the seismic changes to the global economy, we look at the ugly flipside to new-found currency strength – the heavy toll it takes on manufacturing sectors around the world

The pound’s rise last week to .64 is a vote of confidence in Britain as a safe haven. Investors, who have pushed up sterling from .54 a year ago, appreciate the government’s deficit reduction plan and the Bank of England’s support for asset prices through its quantitative easing programme.

But as every country with an appreciating currency knows, there is an ugly flipside. Figures for UK manufacturing show the sector has lost momentum after last year’s booming sales. Export growth has slowed dramatically and City experts and IMF policymakers fear that growing imbalances could set off currency and trade wars as countries fight against each other to limit the impact of global forces.

Andrew Wells, chief investment officer for fixed income at fund manager Fidelity International, said recent events in the eurozone and the battle over the debt ceiling in Washington had rattled confidence in world currency markets.

“Quantitative easing has been blamed for debasing currencies in the developed world, causing significant distortions in global currency markets. While China has been artificially moderating the strength of the yuan to counter these imbalances, Brazil’s real is surging.

“Concerns are growing that this could break out into an all-out currency war; countries like Brazil are becoming increasingly vocal about their displeasure. An obvious side effect has been a surge in commodity prices; its inflationary effects are now being imported into developed economies,” he warned.

But while prices rise for consumers in the UK and elsewhere in the west, rapidly growing nations fear they will suffer the loss of their manufacturing sectors as the price for a strong currency.

In the short term it seems like a great reward to be a safe haven currency or the favoured subject of speculative investment. Foreign investors buy property, and the indigenous property-owning classes become rich, almost overnight. Households with high incomes can travel and shop abroad with a currency that buys them more than they could previously afford.

Import prices are also kept artificially low as the rising value of the currency buys more foreign goods.

This is almost an exact description of the UK in the mid 1990s and has led many analysts to conclude that the collapse in manufacturing under Labour was simply down to the £1 to exchange rate. Economists call it “Dutch disease” – after the experience of the Netherlands whose manufacturing sector withered after its gas industry took off in the 1960s and sent the guilder soaring.

Last week Australia’s strong currency struck a heavy blow to the nation’s manufacturing industry after BlueScope Steel, its largest steelmaker, unveiled plans to shut half of its steel-making capacity, cease exports and slash 1,000 jobs.

The soaring Australian dollar has inflicted an increasing toll on manufacturers, hitting earnings at a time when raw-material costs are also surging.

The Aussie, as it is known, has risen 70% since touching a low of around 60 US cents during the global financial crisis in late 2008 to push past the greenback. It now fetches .04, having climbed as high as .10 last month, a 29-year peak.

“There is no doubt that if the Aussie dollar fell, we would be a much more viable and profitable business and we would look at exports again,” BlueScope’s managing director, Paul O’Malley, said after reporting an annual loss of .1bn.

BlueScope shares, already the third-worst Australian performer so far this year, sank 11% to a record low of A{content}.70 after the announcement. The company also said it would close a blast furnace at Port Kembla, south of Sydney, and would lose half its production capacity to 2.6m tonnes a year.

Local businesses and policymakers are convinced the recent strength of the currency is here to stay as the historic boom in the nation’s mining exports becomes a long-term trend.

The boom, fed by China’s insatiable hunger for resources, is so strong that it can withstand the high currency, but export manufacturers are being forced to slash costs, move production offshore or stop exporting altogether.

Australia’s prime minister, Julia Gillard, acknowledged on Monday that local steelmakers were in trouble in what she called a “patchwork economy”.

“As the resources sector grows, when it’s hungry for people for skills, for infrastructure, when we’re enjoying record terms of trade, when the Australian dollar is so strong, that does put pressure on other industry sectors,” Gillard told reporters.

“We should not conclude from that, that we won’t be a country in the future that manufactures things. We will be a country that manufactures goods.”

The same situation is hitting manufacturers in Japan, where the yen has appreciated against the dollar by about 10% over the past year.

Glenn Uniacke of currency dealer Moneycorp, said traders remained nervous about countries with a weak response to the financial crisis.

He said the Obama administration’s failure to generate jobs and growth in the US had discouraged investors from holding assets in dollars. A recent rise in employment was not enough to change their minds, he said.

If countries like Brazil take unilateral action to halt the rise of their currency by placing further restrictions on foreign capital it could spark retaliation and a further downturn in world trade – pushing the recovery even further away. © Guardian News & Media Limited 2011 | Use of this content is subject to our Terms & Conditions | More Feeds