The world is on the brink of a nasty confrontation over exchange rates - now spilling over to affect trade policy (America's flirtation with protectionism), attitudes toward capital flows (new restrictions in Brazil, Thailand and South Korea) and public support for economic globalization (rising anti-foreigner sentiment almost everywhere).
The issue is usually framed in terms of whether some countries are "cheating" by holding their exchange rates at an undervalued rate, thus boosting their exports and limiting imports relative to what would happen if their central banks freely floated the local currency.
The main culprit in this conventional view is China, although the International Monetary Fund is a close second. But the seriousness of today's situation is primarily due to Europe's refusal to reform global economic governance, compounded by years of political mismanagement and self-deception in the United States.
China certainly bears some responsibility. About a decade ago, Beijing found itself consistently accumulating large amounts of foreign reserves by running a trade surplus and intervening to buy up the dollars this generated. In most countries, such intervention would tend to push up inflation, because the central bank issues local currency in return for dollars. But because the Chinese system remains tightly controlled, the usual inflationary consequences haven't followed.
In principle, the IMF is supposed to press countries with undervalued exchange rates to let their currencies appreciate. The reality, however, is that the IMF has no power over China (or any other country with a current-account surplus). Emerging-market countries are increasingly following China's lead and trying to ensure that they, too, run current-account surpluses; in practice, this means fervent efforts to prevent their currencies from appreciating in value.
A great deal of responsibility for today's global economic dangers rests with America. First, most emerging markets feel their currencies pressed to appreciate by growing capital inflows. Investors in Brazil are being offered yields of 11 per cent, while similar credit risks in the U.S. are paying no more than 3 per cent. Moreover, U.S. rates are likely to stay low, because America's financial system blew itself up so completely (with help from European banks) and because low rates remain part of the post-crisis policy mix.
Second, the U.S. has run record current-account deficits over the past decade, as the political elite - Republican and Democrat alike - became increasingly comfortable with overconsumption. These deficits facilitate the surpluses that emerging markets such as China want to run - the world's current accounts add up to zero, so if one large set of countries wants to run a surplus, someone big needs to run a deficit.
Third, the net flow of capital is from emerging markets to the U.S. But the gross flow of capital is from emerging market to emerging market, through big banks now implicitly backed by the state in both the U.S. and Europe. From the perspective of international investors, banks that are "too big to fail" are the perfect places to park their reserves. But what will these banks do with the funds?
When a similar issued emerged in the 1970s - the "recycling of oil surpluses" - Western banks extended loans to Latin America, Poland and Romania. That led to a massive debt crisis in 1982. We're now heading for something similar, but on a larger scale. The banks and other financial players have every incentive to load up on risk; they get the upside (Wall Street compensation is set to break records again), and taxpayers get the downside.
The "currency wars" themselves are merely a skirmish. The big problem is that the core of the world's financial system has become unstable, and reckless risk-taking will once again lead to great collateral damage.
Simon Johnson, a former chief economist at the IMF, is a professor at MIT Sloan and a senior fellow at the Peterson Institute for International Economics.