Hot Potato: Today in the Currency War

FX can be a mystery, but it is one in which your economic life may well hang in the balance. 

Don’t really care?  OK, but, did you know that a goodly share of the past century’s greatest misfortune was a by-product of this largely ignored sector of the market?

Really?  Yes, really.

More obviously, of course, trade itself – especially in the later stages of colonial imperialism – has long been the impetus for most of the world’s conflicts, perhaps culminating in “the Great War”.  In the aftermath of this, the “War to End All Wars”, amidst the crumbling ashes of the imperial age, the surviving players upped the ante.  You see, the cost of that war, as steep as it was – amounting to as many as 65 million deaths worldwide, in the merely human dimension – was still accruing interest in the economic dimension.

While geographic “spheres of influence” would continue to dominate the world’s attention, many ignored the economic consequences:  those pesky credit and debit entries in the account books;  the reparations, the massive debts, the impaired trade balances, the perilous exchanges of currency, the backing and credit-worthiness of those currencies.  And, it was these issues, really, that laid much of the ground work for the next round of conflict.

While there have always been ethnic, political, and religious manifestations to war, the geo-political realm has tended to obsess over more “practical” concerns, notably:  scarce resources.  And this, we might add, is what economics is all about.

Today’s headlines – specifically Japan’s emergency intervention in the Yen-Dollar market –  underscores the truth of the old adage, “the more things change, the more they stay the same“.  

We might recall, for instance, that our (US) “Great Depression” was, in part, a currency crisis not altogether different from what the Japanese are facing today (and, very possibly, the Chinese tomorrow).  While complicated by the use of gold for the payment of trade balances at the time, the United State’s significant trade surplus (at the time) put a great deal of pressure on our trading partners and, ultimately, set the stage for a series of devaluations and/or trade wars.

Today, absent the exchange of gold, surplus nations are generally left to the buying and selling of currency and their trading partner’s debt securities or other assets.  The “edge of the cliff” for a country such as Japan today is that the appreciation of their currency will make their goods more expensive and, thus, less competitive.  For a country already in the depths of one of (if not) the longest recessions in modern history, replete with slow growth and burgeoning debt, further slowing is not just unacceptable, it may well be an economic death knell.

In the 1930’s, mainstream economists will tell you, it was “imperative” to reject the gold standard, largely to facilitate currency devaluations.  Rarely do they pause to explain how, midstream in what was, in reality, only a banking liquidity crisis (sound familiar?), it was wise to permanently impair the soundness of the dollar in order to temporarily improve the competitive pricing of American goods. 

To be sure, the appreciating dollar (really, the flow of foreign gold to the US) was having a detrimental effect on our export sectors.  Left unabated, perhaps for a time, it might well have led to greater hardship.  But, we might wonder, “greater” than what?  

In a laissez-faire  environment, of course, trade imbalances – for manufactured goods, at least – tend to work themselves out over time.  Higher import prices benefit domestic production until surplus exports and an appreciating currency begin to make import prices more competitive.  There is a natural range of equilibrium that would result, were it not for the manipulative efforts of governments engaging in mercantilist trade policies.  That said, such mechanisms may not work out so well when we’re talking about overly specialized sectors such as agriculture (then) or, worse, oil (now). 

The permanent impairment of our currency, we might note, ultimately paved the way (or “papered over”) the massive public sector spending to which FDR was committed.  The more troubling and longer-term consequences of this sort of trade war strategy, which became a global phenomenon, was that it set the stage for what became the next “War to End All Wars”.

The so-called “race to the bottom” of the currency devaluation strategy will in the end, like a game of chicken (or a more fatal version of musical chairs), create order of magnitude shifts in the balance of global economic power.  Time and again over the past century, these shifts have inflamed the passions of nationalism, of racism, of socialism, of geopolitical aggression. 

One might rationalize extreme responses to survival-level threats, yet, one might also wonder how best to avoid the sort of global entanglements that pose such risks to begin with.  I’d not argue that a sound currency is the only answer to that question, but it is, I believe, a part.  

Today, Japan has upped the ante in what may well be developing into a deadly serious showdown in response to the steady abuse the world is suffering as a result of our monetary policy.  As stated here before, the dollar’s “tangible” value has long been well below that of it’s practical, post-Bretton Woods role might suggest.  There are limits to how often we can expect to cash that check.

Harry Tuttle

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One response to “Hot Potato: Today in the Currency War

  1. Pingback: Currency Update: Dancing in a Minefield | A Reasonable Life

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