Worries rise about a currency crisis

America's trade deficit fell for the sixth time in a row in January -- and that's a problem.

The challenge isn't the 9.7 percent narrowing of the deficit. That's good. The problem is that both imports and exports are both plunging, the Bureau of Economic Analysis reported Friday morning. That's a phenomenon that's happening around the world and putting enormous pressure on export-dependent nations.

It's beginning to squeeze China, which sent a veiled warning to the US on Friday. But for the moment, think Switzerland.

Its central bank on Thursday announced that its economic situation was so bad that it faced the possibility of three years of deflation. The reason: Its exports to the European Union have fallen hard -- partly because of the economic slump and partly because of the appreciation of its currency against the euro.

Exports down? Devalue.

So the bank said it would cut interest rates and sell Swiss francs to "prevent any further appreciation" of its currency. Accordingly, the value of the Swiss franc plummeted 2.6 percent, its largest weekly decline ever against the euro (which came into circulation a decade ago).

What happens next is key. One interpretation is that, once the franc falls to more normal levels -- say, 1.65 francs to the euro -- the Swiss National Bank will stop intervening in currency markets. "If my conjecture is right, they're really holding the line about 1.65," said Richard Cooper, professor of economics at Harvard University, in an interview.

The more ominous interpretation is that the Swiss will go too far and set off a damaging round of currency depreciations around the world. It's really the flip side of the tariff barriers that deepened the Depression in the 1930s. And the results are the same.

Back then, nations protected their domestic companies by limiting imports. In competitive currency devaluations, nations lower the value of their money to help their companies sell more exports abroad.

"If only one or two guys do it, it's not a big deal. But if a lot of people do it, then everybody does," said Morris Goldstein, senior fellow at the Peterson Institute for International Economics, in an interview. "The last thing we need now would be some kind of big currency altercation."

China's warning shot

Which leads back to China. In a speech Friday, Chinese premier Wen Jiabao called on the US "to honor its words, stay a credible nation, and ensure the safety of Chinese assets."

The translation, according to analysts: Don't spend too much on fiscal stimulus because you could devalue the $1 trillion or so we hold in US Treasury and other government-affiliated notes.

China has a related concern. Its exports have already begun to plunge. If the dollar loses value, Chinese products become more expensive for US consumers to buy.

It appears there's little the Chinese can do, analysts say, except dump dollars, which would devalue the greenback anyway.

The International Monetary Fund used to monitor exchange rates, but "in the last couple of years the IMF seems to have gotten out of that business," Mr. Goldstein said. "I think there's going to have to be some kind of international agreement about this."

At their weekend meeting, the G-20 finance ministers will discuss financial regulation and the economic slump. Perhaps Switzerland's action and China's warning shot will help focus their attention on the devaluation dangers that lurk ahead.