A Currency War? It's Just What The Doctor Ordered!

A second round of quantitative easing. Devaluing the dollar. Currency and trade conflicts. What does it all mean?

Let's take an historical view, ignoring the ups and downs of various markets. What is the situation in the United States? The Middle Class is increasingly down and out. It will take a decade or more to recover the jobs lost during the recession. America's manufacturing sector continues its downhill slide. After the meltdown, we fell right back into running large trade deficits—what other outcome was possible? The collapse of the Housing Bubble took away the phony wealth created by rising house prices but the mortgage debt remained behind. The housing market is on a heart-lung machine. Fannie & Freddie are so screwed up that nobody wants to even talk about them.

A massive fiscal stimulus juiced up the economy and then faded—this was predictable and many of us predicted it. The first round of quantitative easing, in which the Fed purchased $1.3 trillion in mortgage-backed securities, lowered interest rates but the problem is debt, not the availability of affordable credit. The Fed's zero short-term interest rates helped the Big Banks and big Wall Street investors but nobody else. Outstanding credit has been falling for almost 2 years. Final demand for goods & services continues to dwindle. Small businesses can't hire. America's public debt now exceeds 100% of GDP. Wealth and income inequality is getting worse, not better. The number of Americans on food stamps or living below the poverty line is rising by leaps and bounds. Etc.

So if you're Tim Geithner or Ben Bernanke, faced with a decline of this magnitude, what do you do? Certainly you don't want to acknowledge how screwed up America is, and will continue to be, because that's just a prescription for personal, political or institutional suicide. What's the answer to all your problems?

We need a war!

We need to shift the blame elsewhere. Find some scapegoats. Distract the people from the real causes of what ails them. Damn the consequences—we'll worry about those later or not at all. After all, John Maynard Keynes observed correctly that "in the long run, we're all dead."

And we've still got two hammers—the dollar is still the world's reserve currency, and we've got world's largest military by far. But we're constrained. We can't wage a traditional blood & guts war on the ground because that would be wholly contrived, and we can't afford the occupation (Iraq) and the losing war (Afghanistan) we've already got.

But we've still got that currency hammer, and those evil export surplus economies certainly do look like nails, don't they? Yes, that's the ticket, we'll wage a "currency war" on those slanty-eyed little bastards. This will leave them with two alternatives: 1) they'll have to allow their currencies to strengthen with respect to the weakening dollar, or 2) they'll have to intervene in the currency markets to keep their paper money competitive with the weakening dollar to support their export markets.

If the surplus countries pursue option #1, we've really got 'em by the short hairs. Remember what happened to Japan after the 1985 Plaza Accord? Those poor schmucks let their currency rise against the dollar and five years later voila! — they've had not one, but two lost decades since then. And if they pursue option #2, well, we can print money, but they can't! We'll flood their economies with worthless paper. They're already very worried about it—

HONG KONG, October 22, 2010 (MarketWatch) — Asian finance ministers and central bankers will use this weekend’s meeting of the Group of 20 major economies to communicate the hardships they face from surging capital inflows and appreciating currencies.

Concerns are mounting that if left unchecked, current trends are creating a bubble that could suddenly burst in replay of the 1997 Asian financial crisis that ended a boom-time for the region.

“We have a situation right now where pretty much every major emerging-market economy is being subjected to a wall of money emanating from the U.S.,” said Cantor Fitzgerald economist Uwe Parpart in Hong Kong.

“The assumption that all of this money is genuine investment money is clearly mistaken — a great deal of it is purely speculative,” he said.

Aside from unnecessarily punishing emerging Asian economies (and Brazil, among others), will the "currency war" actually benefit the United States? Well, no! But that's not the main point of waging the war, is it? Here's Gluskin Sheff's Dave Rosenberg from a recent Breakfast With Dave—

The Fed is pushing on a string and is in a classic liquidity trap but the markets love the prospect of more reserves flowing into risk assets even if the economy is left in the dust. In this respect, the quote of the day goes to former Dallas Fed President Mike Bob McTeer on page B2 of the NYT regarding the move afoot to QE2—

“If you lead the horse to water and it won’t drink, just keep adding water and maybe even spike it …”

Yikes! This will not end well, even if it is next to impossible to say when it does. Page C1 of the WSJ runs with Fed Moves Viewed as Softening the Dollar. The article posits that—

“Investors increasingly believe the U.S. is putting itself at the forefront of the competitive devaluation race. That view is driven in part by the Treasury’s increased pressure on China to allow its currency to rise against the dollar, which would likely result in the dollar falling against a range of other emerging market currencies.”

Since 1985, dollar-yen has sunk nearly 70% and yet the US has the same bilateral deficit with Japan today as it had then. So why does everyone think that a Chinese revaluation will necessarily clear out any perceived imbalances?

Maybe if U.S. policy encouraged thrift over asset-based consumption growth, these trade imbalances would dissipate more quickly.

I put in my two cents on the futility and destructiveness of trashing the dollar in The Fed's QE2 — Speeding Our Demise. I criticized our leaders for blaming our problems on the Asian surplus countries in American Hypocrisy And The Currency War. I noted that QE2 will inflate commodity prices (including oil) in Quantitative Easing, Oil Prices And Recessions. In short, I pointed out all the problems associated with waging this kind of war.

But let's face it: anybody with a functioning brain already knows the Fed is "pushing on a string" as Dave Rosenberg put it. And they already know that "this will not end well." It doesn't matter what Dave Rosenberg or Dave Cohen or any other fully functioning adult says.

If you ask Timmy or Ben, a currency war is just what the doctor ordered! In Isaac Asimov's great science fiction Foundation series, his character Salvor Hardin famously proclaims that "violence is the last refuge of the incompetent." That's certainly true this time around as well.  And taking an historical view of current events, in the context of the Empire's Decline, this "currency war" is also the last refuge of the doomed.

I'll let the Gee Whiz Kid have the last word.

Comments

[Edward Boyle]

So if USD halves or more respective to RMB, Rupee, Real (Brasil), etc. and USA keeps importing pretty much the same amounts of stuff and exporting jobs then its deficit will just grow. These countries won't start importing US goods as they are of poor quality and they can still be made cheaper at home in China due to transport costs, etc. and due to a sort of Buy in China feel for goods (commerce nationalism) among the population which has been lost in USA(i.e. Why buy American when it is better value to buy Japanese, Korean, chinese and you cna't find American goods anyway).

Perhaps when other countries take outsourcing to the extreme the Americans have taken it, will other country´s citizens(consumers, excuse my mistake) think it bigoted and racist and nationalistic to say "Buy Chinese", or similar. I believe the Chinese like foreign luxury goods on the one end and machine tools for production purposes as well as VW and GM cars(made in China mostly). All the Hypermarches and Walmarts in China with global goods sourcing are thriving.

I am not seeing a clear picture here generally. The multis have themselves well positioned to win at any rate as they can hedge their bets wherever production or consumption goes. The nation state is outmoded as an organisational form as it cannot react to the market changes rapidly enough. Essentially in this concept you would have to open all borders to goods and services and workers, immigrants globally until all prices and wages and incomes were the same globally so that it would all make no difference wher something was made or consumed or who was working. Eventually, we can imagine that excess labour capacity would dry up, as is occurring in china, India, bangladesh, with massive strikes as a consequence and the whole gamut of social protection laws that have come about in the western countries following in poorer countries after a similar social justice fight as has occurred in USA/Europe froim 1880s through 1930s. China is 30 years into this phase (1980-2010) so that this is beginning to take place. We could expect a self corrective mechanism to the whole global disbalance, where in one area of the world high wages/ worker's rights/environemntal protection/unions dominate and in another Dickensian brutality is the norm. In the West this has taken place, where unemployment and outsourcing have put the masses out of worker at survival wages and in China the masses have earned a middle class life. We are downwardly socially mobile and they are upwardly socially mobile. The question is where does their upward mobility and our downward mobility stop and balance out? Could we put that into USD or parity units of consumption or perhaps energy consumption terms? Some sort of basic standard of living acceptable to all to integrate China into the Western system so that everyone is happy again like happened with Japan and the East Asian NICS and Eastern Europeans. A fridge, TV, small car and apartment with health insurance, unemployment benefits, job protection, unions, and clean air laws , plus a modicum of civil rights to boot. A sort of mature capitalist system. We hope this of china perhaps. But really the capitalist mulits are always rocking the boat, looking for a better bargain, going away when stability threatens to the next cheaper job market (Indian subcontinent, Africa perhaps). Still the world is only so big and the multis are not nations but just players in a power game (croessus was killed in the end and Khodorkhovsky put in jail when he tried to get into politics).

The system that the economic interest use to their advantage has become so destabilized that the national powers, in the form of central banks and national governemnts and parliaments cannot control it anymore. So you end up with an open system going into an unstable state as in Prigogine´s theories. The system either acheives a higher more stable state (with more energy use by the way to maintain a higher state- enrgy that is dissipating) or collapses back into a previous state of less order and less energy. Since the global system is actually a multinational and not a truly global system (like Europe is a state of nations and not like USA a nation state). The experimnet of globalism must collapse if it does not acheive a global govt. with a single currency and a truly global power center. Instead we have various power centers based on ethnic, religious , historical , cultural differences. The mulitnational companies are hardly an exception as they are ultimately nationally based and not truly global. To make a long story short - Humanity is not one people. As long as Chinese and Americans do not use one set of social rules(unions, environmental, trade, civil rights, etc.), taxation, etc. there will be trade disturbance and unemployment, deficits, surpluses, -imbalances leading to nationalistic political demagoguery and eventually war. After WWII bipolar world plus various 3rd world countries went own ways. Since 1979 (China) and 1990s(East Bloc) the global experiment based on western model has been fully exploited-capitalism on steroids. New World Order experiment is failing as there is no values systems agreement among the participants. Notably Islam and china have differing opinions on allowing western model as prototype. We in the west say they are immature, not having experienced the enlightenment and similar movements in the West. Different developmental models are possible of course. One speculates what if Hitler had won or Napoleon conquered Britain, or if the Chinese had populated the Americas or Russia had taken over all of Europe after WWII?.

We are at an unstable system state and a currency war is just a symptom of this striving towards a new stability but for that you need a new system. Working within the old rules just leads to the collpase of the system. This we see occuring.