Wednesday, November 3, 2010

Exchange Rate Roulette


The world is engaged in a game of "tug of war" that is as unprecedented as it is unpredictable. In the past, the quest to be a net exporter was often managed by import taxes, supply restraints and trade agreements. In the new world of "free" trade countries now are using indirect means to achieve the desirable end of being the world's supplier.

While this concept of currency manipulation is not new, the United States attempts to answer through quantitative easing is in fact new. The real question is what took so long for the United States to answer? Leverage certainly masked the problem for quite some time as corporations created multinational identities with no allegiance to any given population. As Americans saw their wages flat lining due to deflationary wage pressures from overseas and technology advances, Profits soared due to the lower input costs. These profits unfortunately were unsustainable because the American worker no longer fashioned the same sense of purchasing power.

In other words, instead of paying the cost to build it at home so we could afford to consume it, corporations built their goods elsewhere. Through a favorable credit corporations could enjoy these maximized profits by selling their goods to the debased American workforce over time. The problem of course is that one can only lend to a certain threshold and still expect repayment. The second problem is that because of the insufficiency of wages paid to workers in foreign manufacturing countries those workers were not viable as consumers for the goods produced.

Since wealth is not created by income, but rather sustainability of one's standard of living- the American practice of being a net importer was doomed to fail. This failure was systematic and without reprieve. Eventually lending had to slow due to ability of the borrowers to pay. Without lending deflation was almost certain. So it is certain the American worker in mass must produce as much or more than they consume to create sustainability. Americans cannot continue to consume and not produce, because production creates the wages with which they are able to consume. Conversely, wealth is assured if the Americans can produce more than they consume because that surplus is savings. Of course this is the benefit of being a net exporter.

That said, with countries such as Brazil and North Korea limiting and taxing capital inflows that would cause their currencies to naturally appreciate, how does this game end? With Japan and China dedicated to purchasing US dollars to diffuse currency appreciation and undermine the Fed's efforts to devalue the currency, is the end a net wash? Perhaps its a game of chicken that dares the other to veer off of collision course first. If we keep printing money simply for them to buy it up to maintain status quo can capital flows ever reach equilibrium?

In sum, the end game will have to be accomplished through direct means such as treaty or taxes since no one seems to be willing to say "uncle." Of equal importance America will have to deregulate the workplace requirements and union strongholds on issues of workplace standards if America is to compete for the world's jobs in the future.