By Steven K. Beckner

PARIS (MNI) – U.S. Treasury Secretary Timothy Geithner and Federal
Reserve Chairman Ben Bernanke are likely to get an earful about “hot
money” and the United States’ alleged culpability for it in the next
couple of days as Group of 20 finance ministers and central bankers meet
to confront international economic and financial challenges.

But from the standpoint of Geithner and Bernanke, “hot money” flows
into other countries and their inflationary implications are not a
reflection of U.S. monetary or other policies so much as they are an
indictment of the rigid exchange rate policies of China and other U.S.
trading partners.

In sharp contrast to previous G20 meetings, inflation is bound to
be a major topic, though it’s not on the agenda per se. But while
inflation fears are mounting in emerging markets and even in parts of
Europe, they remain minimal in the U.S., making for tension among the
major G20 members.

More officially, G20 policymakers will focus once again on how to
reduce global trade imbalances, and they will be seeking to flesh out an
agreement to tackle that perennial problem which was reached last
November in Seoul by their leaders. There will also be further
discussions about how to strengthen and coordinate international
financial supervision.

Potentially overshadowing all these discussions is the ongoing
European sovereign debt crisis, which has been exacerbated in recent
days by a disappointing Spanish bond auction. A large new euro-zone
bail-out fund, proposed to total 500 billion euros, has been tentatively
agreed upon, but its ultimate fate has been cast in doubt by the abrupt
resignation of Bundesbank President Axel Weber.

With the departure of Weber, heir apparent to Jean Claude Trichet
as the third president of the European Central Bank, German political
support for an enlarged, permanent bail-out fund has come into question.
And that adds another downside risk to the global economy for G20
policymakers to ponder.

While the G20 are sure to reaffirm their desire to “reduce
excessive imbalances,” actually achieving that result is apt to remain a
will-o-the-wisp given conflicting interest, divergent economic trends
and seemingly intractable policy differences.

Most notably, although China last week pegged the yuan/dollar
exchange rate at its highest level ever, it continues to limit the amount
of appreciation it permits — much to the annoyance of the United States
and other advanced countries.

Exchange rates, indeed, are at the heart of both the hot money and
trade imbalance issue, at least as far as U.S. officials are concerned.

The Fed has been accused by China, as well as Brazil and others, of
fueling inflationary “hot money” flows into emerging markets. And the
host French are expected to push for some new system or process for
limiting capital inflows into emerging market countries in Asia and
elsewhere.

It has been proposed that the International Monetary Fund, an eager
participant in the G20 process, be given additional responsibility for
monitoring capital flows and setting guidelines for curbing them if
necessary. Once-deplored capital controls are getting a more favorable
look as a kind of last resort that the IMF is prepared to countenance
in dire circumstances.

“Hot money” is not a new issue. Since the Fed launched its second,
$600 billion round of quantitative easing last Nov. 4, charges have been
flying at the U.S. central bank.

By holding short-term interest rates near zero and buying hundreds
of billions of dollars of assets in an attempt to hold down long-term
interest rates and speed the U.S. recovery, it is contended, the Fed is
generating yield-seeking capital inflows into more rapidly growing
emerging market countries and swelling both asset bubbles and price
pressures.

But while inflation has been visibly mounting in Brazil, China and
other “emerging market nations” and raising alarms in Europe, Bernanke
persisted in calling U.S. inflation “quite low” and inflation
expectations “stable” in testimony before the House Budget Committee
last week.

Confirming what MNI has been reporting, minutes released Wednesday
show that the Fed’s policymaking Federal Open Market Committee
reevaluated the balance of risks and upgraded its forecast of growth,
jobs and inflation at its late January meeting. But the predominant FOMC
view remains that unemployment is still much too high and inflation much
too low to contemplate tightening monetary policy in the near future.

And from the standpoint of Bernanke and Geithner, former president
of the New York Fed, U.S. monetary policy has nothing whatsoever to do
with global price pressures. If there’s an inflation problem, they
argue, it’s because China and other countries insist on keeping their
exchange rates relatively rigid relative to the dollar — thereby
importing a monetary policy which, while appropriate for the relatively
sluggish U.S. economy, is not at all appropriate for fast-growing
economies like China’s.

Instead of trying to rely on interest rates to curb demand and
contain inflation, China should allow the “undervalued” yuan to
appreciate, Bernanke told the House Budget Committee last week. In
short, it should stop tying its wagon to “highly accommodative” Fed
policy, he argued.

The U.S. Treasury has made similar arguments — going so far in the
recent semi-annual exchange rate report to Congress to call the yuan
“substantially undervalued.”

Once again, however, Geithner pulled his punches, declining to
brand China a currency “manipulator” in the Treasury’s semi-annual
foreign exchange report to Congress. The decision is understandable,
perhaps. Accusing China of exchange rate manipulation and thereby
opening the way for trade retaliation against China may not have been
very diplomatic at a time when the U.S. is becoming ever more dependent
on Beijing to finance a record federal budget deficit — expected to
exceed $1.5 trillion this year.

A couple of days ahead of the G20 meeting, a senior U.S. Treasury
official reiterated the U.S. position, saying, “G20 members need to free
up exchange rates to facilitate adjustment. For the global adjustment
process to work, all major economies must allow their currencies to
adjust in line with market forces or risk imposing excess burdens on
others.

“Moreover, with commodity price inflation on the rise, exchange
rate appreciation is key tool in many cases to help dampen inflation,”
the official told reporters in Washington.

“Countries with undervalued currencies should allow their
currencies to appreciate,” said the official, who again called the yuan
“undervalued.” Bernanke has made similar comments on a number of
occasions.

As the second largest economy in the world, China’s currency should
“play a larger role in international transactions over time,” the
official said.

France would like to speed that process along. Its president
Nicolas Sarkozy has said the yuan should become a component of the IMF’s
numeraire The Special Drawing Right or SDR as part of a process of
increasing the yuan’s role as a reserve and transaction currency.

France would also like to advance the cause of “rebalancing” the
world economy.

In their final communique in Seoul, which South Korean President
Lee Myung-bak called “historic,” G20 leaders agreed to “strengthen
multilateral cooperation to promote external sustainability and pursue
the full range of policies conducive to reducing excessive imbalances
and maintaining current account imbalances at sustainable levels.”

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