Currency war with China

[sort of crossposted at BMG, because both parties are equally screwed up about this:]

Here is an issue for you: the futility of devaluing your currency to encourage exports. We are often told that devaluing your currency will lead to export growth. How does this happen? The country, say Mexico, declares that the peso which had traded at 10 per the dollar, will now trade at 11 per dollar. Goods produced in Mexico that used to be worth $1 are now worth 90 cents, which encourages sales.

Unfortunately for the Mexican worker, he has little power in the trade he makes with his employer for his labor. So if he made 100 pesos a day, after the devaluation he still makes 100 pesos, but the value of his pay has actually gone down by 10%. If he has managed to save anything, the value of his savings is slashed by 10%. Maybe he decides to cross the border to the USA, where people will freak out about his presence, even though their own government has pressured the Mexicans to devalue.

Now say this happens in the USA. The dollar which was worth 1 euro is devalued so now it is only worth .9 euros. The worker in the export factory may eventually notice that even though his wage has stayed the same he can’t buy as much. If he is lucky, he has the power to bargain his wage back at least to where it was before. Poof, the competitive advantage of his product is gone.

Why was it done in the first place? To give the export factory owner a backdoor way to cut the wages of his employees. The price advantage comes straight out of the hide of his employees.

Now that you understand what is happening to the dollar, you will see that China has not been “overvaluing” its currency. It has simply kept the Chinese currency pegged to the dollar, devaluing right along with us, offering no fleeting export advantage to US manufactures. That is what has Senator Charles Schumer so mad.

But what about you and I and the export worker? Haven’t we seen the dollar slump to where it buys 1/5 the gold it did? Don’t we see prices for gas and food rising? Don’t we feel the stagnation of our standard of living? Don’t we count in this?

From The Wall Street Journal:  

Since the financial panic began in 2008, global leaders have been at pains to stress their “cooperation” on numerous issues-stimulus spending, new bank rules, trade. Yet they still insist on going their own parochial, self-interested way on monetary policy and exchange rates. It’s as if world leaders had consciously decided to deal with every economic issue except the most important one-the price of the global medium of economic exchange.

The result has been a world of monetary disruption and growing commercial and political disputes. Brazil has had to cope with surging capital inflows and a rising real, with government bond yields hitting double-digits. The rising yen has roiled Japanese politics and led its central bank to intervene. Other Asian nations-part of what is, or was, the dollar bloc-have taken to devaluation or interest rate adjustments to stop their currency shifts against the dollar.

Meanwhile, what Nobel economist Robert Mundell calls the world’s single most important price-the euro-dollar rate-continues to fluctuate wildly. The nearby chart shows that the swings have become more frequent and severe since 2005, from 1.2 euros to the dollar to 1.6, then down to 1.25, back to 1.5 in a matter of months, down again to 1.2 and now back above


Mr. Mundell-the father of the euro and the world’s foremost expert on currency systems-recently said on Bloomberg TV that this “is a terrible thing for the world economy” and that “We’ve never been in this unstable position in the entire currency history of 3,000 years.”

Such sharp currency moves lead to huge swings in prices, especially for commodities like oil. They disrupt business planning, as companies find it difficult to know what their real costs and return on investment will be. And they lead to the misallocation of resources, with investment decisions pegged as much to exchange-rate movements as to long-run productivity gains or potential breakthroughs in technology. Some $4 trillion now turns over daily in global currency markets.

The growing danger today is currency protectionism-what students of the 1930s will remember as competitive devaluation or “beggar-thy-neighbor” policies. As economic historian Charles Kindleberger describes in his classic “The World in Depression,” nations under domestic political pressure sought economic advantage by devaluing their national currency to improve their terms of trade.

But that advantage came at the expense of everyone else. “As with exchange depreciation to raise domestic prices, the gain for one country was a loss for all,” Kindleberger writes. “With tariff retaliation and competitive depreciation, mutual losses were certain.”

We can see signs of similar behavior today, especially in the global economy’s main potential flash point of U.S.-China relations. This week, the U.S. House of Representatives voted 348 to 79 to impose tariffs on Chinese goods if Beijing does not revalue its currency. Ominously, the vote was bipartisan. While the Senate has so far restrained itself, a similar rout in that body can’t be ruled out after the elections-especially in the absence of Presidential leadership.


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