by Gary North
I never saw the movie Deliverance. I'm told it's a classic. The story line didn't much appeal to me. But I'm grateful for one thing: it made "Dueling Banjos" a classic. They even used the original version by a pair of good old boys from New York City, Eric Weisberg (banjo) and Steve Mandel (guitar). The two of them start out slow and then unexpectedly speed up, each trying to go faster than the other in a back-and-forth contest. It's as good an intro to Scruggs-style banjo picking as there is. By the end of the song, city-slickers are wide-eyed the first time they hear it. They didn't know what to expect when it started out.
It's the same way with dueling currencies. Most people don't know what to expect when it starts out. But they know when it's over.
We are now getting into the early stages of dueling currencies. Like distant cousins from Philadelphia at a Saturday night hoedown in backwoods Georgia, newcomers are sitting there, kind of wondering what's going to happen next.
Americans as consumers are about to receive a subsidy from Asian governments at the expense of Asian consumers. This subsidy may last a year or two. It may last longer. This policy of subsidizing American consumers will also benefit America's capital markets, especially the bond market. Foreigners are going to buy more American IOU's. They have already bought $1.3 trillion dollars' worth. They have bought $1.6 trillion in stocks. Total foreign assets invested in the U.S. at market value in late 2000 was almost $9.4 trillion. (Figures in Survey of Current Business, July, 2001, Table 1.) At some point, this policy will backfire on them. The value of the dollar will fall. This will lead to a sell-off of American debt by foreigners. This will produce an increase in long-term interest rates. That will be bad for American holders of mortgages and bonds. It will be bad for the capital markets generally. But that will be later. This is now.
Asia appears to be about to offer Americans the best of both worlds: cheaper goods for sale here and more demand for our stocks and bonds. This doesn't mean that we will experience either price deflation or a stock market boom. Foreign trade constitutes about 20% of the U.S. economy. But these twin benefits will make us richer than we would otherwise have been . . . for as long as dueling currencies abroad continues. Bad economic theory believed by Asia's decision-makers is going to make us beneficiaries for a time. This is good news, temporarily.
The average American investor doesn't understand any of this because he doesn't understand foreign trade. The topic of trade and currency confuses him. So, he ignores it.
I hope I can make things clearer. Here goes. . . .
We are seeing the beginning of a trade war. I don't mean a deliberate government war against trade, as when legislatures hike tariffs (sales taxes on imported goods) and import quotas. I mean a war for trade that is fought by central bankers, who seek to reduce their national currencies' value. It's a war for exports (yea!) at the expense of imports (are you sure?).
Asian governments are quietly conducting this war, officially because their economies are more export-driven than ours is. Unofficially, it is because the world is in a recession, and they think that new issues of bank credit money will end it — a belief shared by Alan Greenspan and George W. Bush. To understand their war for trade through currency depreciation, and why it will surely backfire, you must first understand traditional wars against trade.
TRADITIONAL WARS AGAINST TRADE
Trade is a two-way street. As Pearl Bailey sang half a century ago, it takes two to tango. But governments don't really believe this. They think they can coerce foreign trade partners and still make a national profit. Their coercion produces an excess of lonely domestic dancers. Nobody from abroad invites them to the prom. They have to settle for someone closer to home who is not a good dancer and isn't much to look at, either.
Here is how unregulated trade works. Foreign exporters sell goods to domestic importers in exchange for money. Usually, foreign exporters want payment in their nation's currency. So, domestic importers of goods first must buy this foreign currency in the international currency market by selling their own nation's currency. This tends to lower the value of the importing nation's currency in relation to the exporting foreign nation's currency.
At the same time, there are exporters of goods inside the importing nation's borders. They are seeking the same kind of arrangement with foreign importers.
In a balance-of-trade situation, the rise in demand for the two currencies offsets any change in their mutual price, one against another. There are buyers and sellers of both of these currencies on both sides of the border. Goods cross the border, but the two currencies' exchange rate remains relatively stable.
Consumers on both sides of the border benefit from increased trade. Their individual wealth increases. This is another way of saying that their range of consumer choice increases.
If the government in one nation passes a law that reduces imports from abroad, it thereby necessarily reduces the ability of foreign buyers of the nation's exports to obtain the exporting nation's currency at a lower price. Example: say that Japan passes a tariff against the import of rice. (Japan has done this for decades.) If an American importer of Japanese cameras has to pay more dollars to buy yen than would have been the case had a Japanese importer of American rice bought that rice, then he will import fewer cameras. An direct import restriction is also an indirect export restriction.
It takes two to tango.
Domestic importers of foreign goods (rice) who have now been priced out of the market by the new trade restriction are no longer out there buying the exporting nation's currency (dollars). The value of the importing nation's currency (yen) therefore starts to rise. So, some foreigners who want to buy goods (cameras) from the (rice-) importing nation (Japan) or invest in its industries (Nikkei) are priced out of the currency market (yen). There will be reduced trade and reduced investment.
One more time: if government policies reduce imports, they also necessarily reduce exports. If foreigners are prohibited by law (tariffs or import quotas) from selling their wares, then other foreigners in that other nation will have to pay more money to buy the trade-restricting nation's currency. This money would otherwise be used either to invest inside the importing nation (Nikkei) or buy goods from its exporters (cameras). So, a tariff or import quota necessarily reduces exports, and it also reduces demand in the trade-restricting nation's capital markets. Trade restrictions are therefore bad economics for domestic consumers.
Tariffs do have a political side-benefit that import quota limits don't: they raise revenue for the government. They are sales taxes. Then again, if tariffs are raised too high, this could throw the nation into a recession. Then total tax revenues will fall, and unemployment-related welfare expenditures will rise. But import quotas could have the same negative effect, but without any sales tax revenues.
Tariffs are popular with voters because tariffs are not understood for what they really are: taxes on domestic consumers. They are regarded by the voting public as taxes only on foreign exporters who are seen as using "unfair cut-throat competition" to sell their wares here, at the expense of Our Guys. Domestic competitors of the foreign producers call for tariffs to "help the nation's workers." What they really mean is "help a handful of industries at the expense of the nation's consumers, who will have to pay higher prices for domestically produced goods."
A tariff is not a tax on foreign exporters at all. Consumers are economically sovereign. They inescapably pay the tax when they buy imported products. If there is no sale, there is no tax revenue. A tariff is therefore a tax on domestic consumers of imported goods.
A tariff has negative effects on any foreign exporters who don't make a sale because the tariff has killed the deal. A tariff also has wealth-reducing effects on all those domestic consumers who would otherwise have bought the imported items, but didn't because of the new sales tax. Their wealth has been reduced because their range of choice as consumers has been reduced. But the sales tax is paid only by domestic purchasers of the imported goods. They provide the government's revenue. Their money pays the tax: no sale, no revenue.
If a tariff is a war against trade, then isn't a policy of currency depreciation a war for trade? Won't it increase imports and exports? No. Unlike free trade, in which importers and exporters expand the domestic markets on both sides of the border, thereby making consumers on both sides better off, a currency war undermines the mutuality of trade by attempting to expand exports of goods, but also reducing imports of goods. But it always takes two to tango. So, a currency-depreciation policy increases the export of domestic goods temporarily, but it also increases the flow of capital to the foreign country. This is rarely understood by politicians or voters.
An (Japanese) exporter of goods accumulates foreign currency (say, dollars) that he makes by selling goods abroad (to Americans). He cannot spend dollars back home. So, he now wants to sell these dollars. Who wants to buy them? He will not sell to an importer of goods inside his own country. Why not? Because the government's policy of driving down the international value of the nation's currency (yen) has raised the price of imported goods. This has reduced demand for dollars to buy foreign (American) goods. So, who will buy the exporter's dollars?
There is another large domestic group who buy dollars: investors who want to invest these dollars in America's capital markets. Why do they want to do that? To escape the depreciating domestic currency (yen). The government's policy of currency depreciation rewards those citizens who are skeptical of the government's policies and who buy foreign currency assets before the depreciation continues.
A currency-depreciation war for increased exports is not perceived by the nation's voters as a subsidy to domestic exporters at the expense of domestic importers. The depreciation of the nation's currency unit in international exchange has a negative effect on importers of goods that is the same as a tariff's effects: reduced domestic sales. The importer has to pay more to buy the foreign currency that a foreign seller of goods wants in exchange. But, instead of this reduction of sales being accompanied by increased sales tax revenue, the reduction merely limits consumer choice. It's more like an import quota than a tariff in its absence of sales tax revenues.
There are losers on both sides of the border. Efficient exporters in foreign countries lose because they are kept from passing on benefits to consumers in the importing nation by offering cheaper goods. At the same time, domestic consumers are forced to pay higher prices for imported goods because the price of the foreign currency has risen.
There are winners, of course: (1) exporters in the home country who, because of the currency depreciation, now sell goods to foreigners instead of to the folks at home; and (2) investors who live in the home country who previously had sold the national currency and had bought the foreign country's currency before the currency war began. These investors then think to themselves, "I'll do this again!" So, they invest even more money in the foreign nation. They sell their nation's depreciating currency in order to buy the appreciating foreign currency. This depreciates their nation's currency even more. The government gets it wish: reduced currency value. Foreigners get the benefits.
This is a self-defeating, wealth-reducing government policy. It is a really stupid government policy. That is to say, it is a typical government policy.
In this case, the beneficiaries will be Americans. American consumers will buy cheaper imports, i.e., goods that foreign consumers would like to have but cannot afford. American consumers will outbid Asian consumers because foreign currencies are depreciating in relation to the dollar. Meanwhile, Asian investors are going to buy more American corporate stocks and bonds, making additional capital available for American workers.
These days, Asian investors love to buy American corporate bonds. So do other foreigners. According to Sean Corrigan, whose figures I trust, 74% of the value of all corporate bond purchases made by foreigners over the last 50 years took place in 1995-2001. So did 79% of Government Sponsored Enterprises (GSE's) (e.g., Fannie Mae, Freddy Mac) purchases. (Corrigan, "Coping in a Bear Market," Mises Institute, January 25.)
VOTERS ARE IGNORANT
You would not imagine that a nation's consumers would vote for politicians who impose a trade policy that cheats them by reducing their range of consumer choice, but they do. They vote for currency depreciation because "it's good for exports." They think that it's a good thing to increase exports except in war time or times of famine. During a famine, voters call for laws against the export of food. This makes a lot more sense than deliberately depreciating the nation's currency in order to reduce domestic consumption and subsidize foreign consumers. But, in peace and war, voters are not well-informed on economic reasoning.
Exports are seen as a great thing compared to imports. This is a legacy of 17th-century mercantilism, which Adam Smith tried to refute, but which still is widely believed by voters and politicians. Back then, the policy of export subsidies had to do with building up a nation's supply of gold. That was before the twentieth century, when most of world's gold was stolen by the central banks.
Building up a hoard of gold is no longer the politicians' goal for "fair trade" (regulated) policy. The political goal today is to subsidize businesses that export goods. The effect of this policy is to reduce the supply of foreign products offered for sale to domestic consumers, and also to increase investments abroad by domestic investors.
HOW THE DEED IS DONE
A central bank can't depreciate the national currency in relation to another currency just by issuing a decree: "Currency go down!" The free market sets exchange rates between currencies. Central banks don't. So, a nation's central bankers have to do something to increase the supply of the domestic currency in order to depreciate it. They have to create more of their currency than foreign central bankers in the other country are creating. Also, they have to persuade currency speculators that the new policy is permanent, or at least longer than 72 hours, which is the long run for currency speculators.
To depreciate a domestic currency against a foreign currency, a nation's central bankers must depreciate the future domestic value of the national currency compared with today's domestic value. Central bankers do not have the power to (1) raise the price of a foreign currency and not also (2) push domestic prices in the same general direction. It is not that foreign imports rise in price, leaving other prices stable. It is that all domestic prices tend to rise in price. other things being equal. More money chases fewer goods (reduced imports).
How can a nation's central bank target a single foreign currency (e.g., the dollar)? It creates new money. This is what central banks do most of the time. Then the central bank uses this newly created domestic money to buy the foreign nation's currency in international markets. It simultaneously purchases the foreign government's debt. This monetary policy drives down the value of the domestic currency in relation to the foreign currency (the dollar).
A currency-depreciation policy has exchange rate effects before it has domestic price effects, at least short of a national currency meltdown, such as in central Europe, 1922-23. Currency traders immediately bid up the price of the targeted currency (the dollar). It takes much longer for consumers at home to figure out that "money just doesn't go as far as it used to." Imports (from America) are likely to rise in price first. This reduces the quantity demanded: fewer imports. Some domestic producers can then raise prices: reduced competition from abroad.
As imports fall, exports rise. Foreigner consumers (Americans) receive a subsidy from the exporting nation's central bank: lower prices across the board because the currency has fallen in value. Foreigners, being rational, start increasing their demand for goods made in the exporting country. Out flow the goods. So, consumers in the home country get a double whammy: more money at home chasing fewer goods. Prices rise.
Why is this a good deal for the average Joe, or in this case, the average Mitsuo? It isn't. Yes, there are not-so-average Mitsuos who work in the export sector of the economy. Maybe they will keep their jobs. But the export sector is always relatively small except in nations like Hong Kong and Singapore.
American consumers are about to receive a nice little subsidy. Two things are about to happen. First, Asian goods sold for dollars will get cheaper as Asian central bankers attempt to stay ahead of their neighboring nations in the currency debasement wars. Americans are going to be treated to what I call "bargain debasement prices," also known as the Japanese brother-in-law deal.
Foreigners who previously unloaded their home currencies to buy American assets now receive a windfall profit. Every time their currency depreciates by 10%, they are winners by about 10%, assuming the market price of American capital assets stays the same here. So, they think to themselves, "Maybe it's time to buy more dollar-denominated assets." They buy more by selling their home currency, which lowers its price, which proves them right again, which makes more units of their foreign currency available to Americans, so Americans buy more imports. It's a vicious circle for foreign consumers, and a kinder, gentler circle for American consumers.
Then what about the future of the dollar? For all you sixties' NBA fans, let me describe the dollar by saying that the dollar is in Elgin Baylor mode. For seventies' fans, it's in Dr. J mode. It's hanging up there, while the defenders are falling back toward the earth.
But this has its negative side-effects: (1) increasing dependence of Americans on a stupid foreign government policy; (2) more leeway for the Federal Reserve System to inflate the dollar.
MORAL HAZARDS AND OTHER BANKING MYTHS
Central bankers want to keep domestic economic booms alive. Once they begin to inflate the currency in order to produce a boom, or to revive a stalled one, the same process of capital malinvestment begins. Entrepreneurs borrow money in order to buy capital goods. Interest rates are lower because the new credit money has been injected into the economy by commercial banks. It looks as though consumers are saving more money. They aren't. It's an illusion caused by the interest-rate effect of the newly created money. On this process of central bank deception and entrepreneurial malinvestment, see my recent essay:
In Asia, recession is now engulfing every developed nation. Undeveloped China keeps its money machine rolling at high speeds — 16% per annum (M-1) — but the domestic demand for cash balances remains high because the capitalist division of labor money economy is spreading into the inland rural regions. Production keeps increasing in this rapidly developing nation. Prices are not skyrocketing yet. They will, but not yet. The demand for money is still very high.
To keep their national recessions from getting worse, Asian central banks are inflating their currencies. The justification for this policy, at least the one that we read about, is that Asian nations are involved in a battle for exports, which flow mainly into the U.S. and secondarily into Europe.
I am not convinced that this is the primary reason. Asian central bankers have read American textbooks, attended the same big-name American universities, and are familiar with the thesis of Friedman & Schwartz's Monetary History of the United States (1963), which blamed the Great Depression in America on deflationary policies by the FED. They think that monetary inflation is the first line of defense against recession. Also the second line. It's the bottom line.
They are all imitating Alan Greenspan. They are cranking up the digital printing presses in an attempt to bring back prosperity, not through exports alone but also by stimulating capital investment, which was Keynes's policy, too. Keynes thought that fiscal policy — government deficits — was the way to achieve this, not monetary policy. But central banks have no control over taxation and spending and deficits. They do have control over money. So, they use it.
The dollar is being inflated by the FED. The rate of increase of FED's balance sheet over the last 30 years has increased at a rate of 6.8% per annum, according to Sean Corrigan. So, today's inflation is nothing new. What is new is Asia's even higher inflation rate.
Why aren't American prices rising? Well, they are rising. They have not stopped rising since World War II broke out. They are not rising as fast as they did in the late 1990's, but they are still rising. The rate of increase is slowing. There are reasons for this. The trouble is, economists don't agree on these reasons.
In Japan, falling prices in the real estate market for a decade have lowered the price level. The bubble economy raised prices of imputed goods to astronomical levels. Then the buyers departed, leaving banks saddled with a mountain of bad debt. The expected income streams on which the imputations had been made had to be revised downward. That brought down the market value of the income-generating assets.
This same scenario is playing out across industrialized Asia. The expected streams of income are being revised downward, and this is killing the imputed goods markets. This is the mark of a looming great contraction. This is what Greenspan fears most. Every central banker does. Why? Because a central bank's main job is to protect the solvency of the fractionally reserved commercial banking system within its borders. It is a cartel of cartels. It's job is to create "moral hazard": banks that are not allowed to fail because they are "too big to fail," meaning too big for a central bank to allow one of them to fail. Greenspan gives nice speeches against moral hazard, which is ironic. Every central bank's primary task is to reduce the threat of a systemic failure of payments. This means that its job is to create the conditions of moral hazard.
The international monetary system is leveraged: gold at the bottom (central banks sit on most of it), government debt in the monetary bases, commercial bank credit at the top. Today, central banks keep mostly U.S. dollar-denominated government debt as their foreign currency component of their reserves. China now has $200 billion in foreign exchange reserves. (See Table, Foreign Exchange Reserves.)
For as long as the world thinks their currencies will continue to depreciate against the dollar, foreigners will sell their own currencies and invest here. For as long as they invest here, Americans will buy their goods. The problem will comes for American consumers when foreigners finally decide that the depreciation of their own currencies has ended. But Asian central banks keep following policies that persuade sophisticated Asian investors that investing in the dollar is the way to hedge against the depreciation of their own currencies.
Bad economic policies by a government always end in the erosion of wealth by its citizens. For a time, those on the receiving end of the bad policies' subsidies are beneficiaries.
American corporations that compete directly with foreign manufacturers are in for a hard time. But these are a minority of American manufacturers. In any case, manufacturing in total is less than 20% of the U.S. economy. So, most Americans will benefit from the subsidies. Dueling Asian currencies are subsidies to American consumers.
These subsidies will end. Inflation in Asian nations, accompanied by reduced output (their capital is flowing here, not staying home). It will create recessions, as inflation always does. There will be a negative reaction politically. This could take years unless the dollar begins to fall on the currency markets. But this could take years, since the goal of dueling currencies is to keep the dollar high.
It's nice for consumers while it lasts. But American consumers are becoming more dependent on bad policies by Asians. They are saving less than ever before. They are letting foreigners support American capital markets. To keep this process going, Americans will have to become more producing than Asians and other foreigners. They will have to save more. They will have to use these temporary subsidies from abroad to make themselves leaner and meaner. I don't see this happening. I see a highly present-oriented, high-consumption population that is being subsidized at home and abroad. I see a nation where individuals increasingly refuse to save: negative 1% for personal savings. I see Americans losing their competitive edge, unaware that they are losing their edge, unaware that constant self-improvement is mandatory for long-term wealth.
The Chinese save. They are hungry. They are self-disciplined. They are now the recipients of vast infusions of capital from Taiwan: over $180 billion since 1991. (Chart: Cumulative Mainland Investment by Taiwanese Businesses) China is fast becoming the economic wave of the future.
The subsidies to Americans from dueling Asian currencies will not last forever. When it ends, the beneficiaries had better be ready to compete with Asia without any further subsidies from Asian central banks. The necessary preparation does not appear to be happening.
January 30 , 2002
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