Martin Wolf: The US will win the currency war; given that, maybe everyone could just get along...

To put it crudely, the US wants to inflate the rest of the world, while the latter is trying to deflate the US. The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world...

US policymakers will do whatever is required to avoid deflation. Indeed, the Fed will keep going until the US is satisfactorily reflated. What that effort does to the rest of the world is not its concern.

The global consequences are evident: the policy will raise prices of long-term assets and encourage capital to flow into countries with less expansionary monetary policies (such as Switzerland) or higher returns (such as emerging economies). This is what is happening. The Washington-based Institute for International Finance forecasts net inflows of capital from abroad into emerging economies of more than $800bn in 2010 and 2011...

Recipients of the capital inflow, be they advanced or emerging countries, face uncomfortable choices: let the exchange rate appreciate, so impairing external competitiveness; intervene in currency markets, so accumulating unwanted dollars, threatening domestic monetary stability and impairing external competitiveness; or curb the capital inflow, via taxes and controls. Historically, governments have chosen combinations of all three. That will be the case this time, too.

Naturally, one could imagine an opposite course. Indeed, China objects to the huge US fiscal deficits and unconventional monetary policies. China is also determined to keep inflation down at home and limit the appreciation of its currency. The implication of this policy is clear: adjustments in real exchange rates should occur via falling US domestic prices. China wants to impose a deflationary adjustment on the US, just as Germany is doing to Greece. This is not going to happen. Nor would it be in China’s interest if it did. As a creditor, it would enjoy an increase in the real value of its claims on the US. But US deflation would threaten a world slump.  [link]