losing the global currency war

[grapejelly]

A great essay by George Karahalios that you should read.

Some excerpts:

Precisely. By the early 1990s a number of circumstances simultaneously converged that would entice every major economy into a global trade war characterized by currency pegs, liquidity creation, and capital controls. America’s loose monetary policy quickly translated into lower interest rates and more Chinese manufacturing jobs. Developing Asia followed China’s lead to become competitive by also engaging in currency devaluation. Japan continued to fight its deflation that was the consequence of its previous trade war with America by running the printing presses at full steam. Both Latin American and Middle-Eastern countries became co-sponsors of the trade war by embracing the dollarization of their economies. Even the European community, which has a history of severe inflations, was forced to participate in liquidity creation. If the Euro were to remain the sole currency free to fluctuate, then European exports would become too pricy to sustain job creation. Thus, at the very least the Europeans would succumb to the pressure to create liquidity in order to stimulate their economies. Thus, as long as each region finds it to be in its own self-interest to continue weakening its currency or producing excess liquidity, it’s quite likely that the currency trade wars will continue along with a synchronous global boom. Broad money measures will continue to expand around the world until one country flinches and changes its tactics, thus triggering a chain reaction that could cause all nations to reassess their strategies as the circumstances change. Until this moment occurs, the debt super-cycle is poised to grow.
BUBBLE:	But why would America ever abandon its participation in this global currency war? After all, buying cheap foreign goods or borrowing at below free market rates doesn’t sound like too bad a deal to me.
BUST:	Your point is a good one. Unfortunately, when money is printed out of thin air by an accommodative Fed, it does not represent savings. Given the global circumstance, this liquidity flowed into assets, allowing Americans to borrow at increasingly lower real rates. One could have made many arguments as to why America should not have wanted to leverage its economy in order to consume itself to death. Now that it has happened, and America has lost most of its industrial base, it could prove very painful for its asset-inflation dependant economy to sustain itself if it suddenly withdraws from a global strategy that subsidizes both its currency and its interest rate. As long as increasing the debt produces some GDP growth, it may prove in America’s best short-term interest to continue piling up debt. Even if all of the parties to this currency trade war continue their participation, eventually more debt will result in flat or even negative GDP production. This, of course, might be ample reason to motivate foreigners to abandon their strategy of currency manipulation, but even if they don’t, it may finally behoove US politicians to withdraw their support for debt creation and adopt a coherent, long-term strategy. The article (a Socratic dialog really) goes on to discuss how the "global currency wars" might end. Terrific piece. And one thing it brings home is the idea of currency repatriation -- foreigners using their US$ to buy assets in the US, while US working class provide the labor and keep seeing their standard of living fall, while asset rich Americans get even richer... That can't be happening...

Last edited by grapejelly; May 08, 2007, 05:27 PM.

[bill]

Re: losing the global currency war

Certainly not. In fact, it’s more likely that the U.S. might try to re-direct some of its liquidity before its imbalances cause the general economy to deteriorate badly. Prior to the imposition of the currency wars, America’s infrastructure had been decaying. The left objected to public contracts for private firms that did not pay union scale wages, while the right would advocate for government expenditures that benefited oligopolies, such as defense contractors. Both parties refused to engage in the concept of “incrementalism,” accepting change via small steps, often through compromise. This resulted in complete polarization on certain issues. If ever there has been a time for America to invest in its infrastructure by issuing debt, the low real interest rates that are a by product of the global currency wars certainly now provide this opportunity. In fact, the Governor of California, a European transplant I might add, recently supported billions of dollars in bonds to improve the state’s deteriorating schools, highways, bridges, aqueducts and other infrastructure. In spite of the opposition of his own party members, these bonds passed overwhelmingly.
BUBBLE:	That’s a problem with America – our leftist politicians always resort to their socialist leanings. If there’s one thing that will doom America, it’s adopting an even greater socialist framework.
BUST:	The governor believes that if his state can borrow at long term rates near 5% and make investments that will yield more than that for his constituents over the long run, it might be in his state’s best interest to proceed. As long as it is foreigners who continue to subsidize these low real interest rates, it is a viable strategy for the US to pursue. In fact, as other states and the federal government embark on this strategy, it is possible that the current decline in GDP growth per dollar of new debt added could slow. In essence, given the circumstance of the currency war, additional public sector debt could deliver more effective wealth and job creation than increased private sector debt.

I could imagine even ardent conservatives eventually favoring infrastructure investment financed by public debt if it helps to keep the social order.

And what will they do with these dollar reserves, burn them?

BUST:

Very humorous, but you make a valid point. If the Chinese believe that liquidating their dollar investments might cause too much disruption to their own economy, it’s possible that they will just sit on them until inflation eventually erodes their value. Ironically, this would be tantamount to what the US does every so often with its loans to third world countries – it just writes them off. Recently, though, the Chinese government announced that it is establishing an investment fund to diversify up to 1/3 of its current one trillion dollars in reserves, and any future reserves earned, which are now growing at over $100 billion dollars per year. If the Chinese follow through with their proposal, it is possible that many of these US dollar reserves will eventually be re-cycled through the global markets and returned to the US where they will be used to purchase US companies, well located US property, or even US infrastructure wherever possible.

Great Article, how many times did I read Infrastructure, Infrastructure, Infrastructure.
I have said many times in my post, Infrastructure in the US will create Jobs for those in need of a job to pay the mortgage, they won’t complain with a job.

Sit on all those dollars and watch them devalue, I don’t think so. For Japan , China and ASEAN to create a reserve pool and sit and watch their dollars burn, no way. I would predict Japan gets the Management position for all those reserve funds. It will be Japan to present the package of Nuclear power plants, toll roads, water infrastructure ect.ect to the America public. I say it gets done with Japan the ones with all the experience going back to the 70’s.

[grapejelly]

Re: losing the global currency war

I think my summary of this is that interest rates are subsidized. Some countries keep interest rates artificially low.

From that flows everything else.

[Finster]

Re: losing the global currency war

...
The article (a Socratic dialog really) goes on to discuss how the "global currency wars" might end. Terrific piece...

You bet, GJ. The irony of course is that in this perverse kind of war, the "winner" is the "loser".

The inevitable outcome of a race to the bottom...