The Currency Seesaw

Picture two children on a Seesaw. One child elevated in the air feverishly jumping on his seat in an attempt to push himself back towards the ground. The other child sternly seated on his seat with his feet anchored under steal stirrups in the sand refusing to allow his seat to move up towards the sky. Can you picture it? Could you picture the balance difficulties of the child in the air as he pounces on his seat to push it down? Can you imagine the bruising of the crotch being experienced by the child who is attempting to anchor himself down? If you can, you now understand precisely the relationship of the US Fed vs. emerging markets' central banks.

If you ever wondered why the Federal Reserve Policies are failing to create the desired inflation in the United States, the answer would clearly be the trade deficit. If you then wondered why the rest of the world is struggling with food and commodity inflation, the answer would clearly be their resistance to currency appreciation.

Of course it is no secret that every country is better off as a net exporter. Collecting money instead of paying it is always the path to greater wealth. That said, the great equalizer is currency appreciation. Currency appreciation is the only way that the two children peaceably stay in balance on the seesaw. As one country purchases, or imports goods, from another it must purchase the exporting country's currency (a capital inflow) to complete the transaction. When this purchase occurs on a frequent basis the exporting country experiences currency appreciation which reduces the cost advantage it has in producing exports. With that appreciation, the population of the exporting country realizes greater purchasing power and higher standards of living for its population. The exporting country over time becomes better able to import at a more affordable rate and becomes progressively more stable as an economy due to purchasing power. Thus, the seesaw is able to balance the children according to their actual weight or on each country's production on the merits of the goods, rather than just input costs.

However, what does a net exporter do if they wish to protect their status as an "Exporter?" Well, you surely figured this one out. They manipulate their currency by making capital inflows less attractive and/or interfering in the currency exchanges. Sound familiar? Japan selling Yen for US Dollars, Brazil placing exorbitant taxes on capital inflows, China exchanging Yuan for US Dollars in a closed government controlled non-market based exchange and India raising interest rates (In India's case this certainly isn't going to work in battling currency inflation is it? But that is a topic for a different article. Higher interest rates=greater rates of return for foreign currencies).

What is the fallout of a country purposely holding its currency down? Items that are valued in US Dollars such as food, fuel and steel etc. get rather expensive for its population as they are being paid for their production in the currency that is being devalued by their government. Unable to provide comfortably for basic needs such populations may resort to civil unrest or similar types of behavior. Sound familiar?

The net result is exporters that refuse to accept currency appreciation disallow the seesaw to find balance. The country in the air (the US) will stay in the air unable to create substantial jobs due to its HIGH currency valuation and inability to compete with lower employment costs. Its population will be reduced to balancing deficits, both fiscal and trade, while confined to its space on the surface area of the seat well above the ground. Unable to expand, the US may attempt to print its currency at an alarming rate- effectively jumping up and down on that seat to become more competitive and create growth. Emerging markets may insist on anchoring into the stirrups on the ground and edure the great discomfort from the seat punding against their unmentionables to maintain their position. In such a scenario the worst of results occurs if one of the parties breaks the others resistance sending one into the tree and the other face down into the dirt.

So, the next time the US Treasury Secretary states that China, "Must allow its currency to appreciate to create balance," think of him saying, "Let us down you creeps." Conversely, when you hear China respond with "It is in both of our interests for our currency to appreciate but it must be gradual,"- remember it is better to take it groin than to be hopelessly stuck in the tree.

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.

Don't Buy the Hype, a Trade War is Exactly What We Need

In the short run, trade wars can cause some pain and some market shortages; but in the long run, one can argue that they strengthen those nations that are capable of self sustenance against those that are not.  While many correctly argue that the protectionism prolonged the Great Depression, protectionism also developed an unprecedented concept, the middle class, which allowed the United States to grow and thrive for over sixty years.  Thus, short term pain led to long term dominance including a dominating presence in the Second World War.

Simple math, GDP= G+C+I+(e-i).  The letters e and i represent imports and exports, and the difference of the two is defined as net exports.  If exports exceed imports an economy gets a boost from international trade, if imports exceed exports the number is negative thus creating a drag on the country's GDP.  Since positive GDP is desirable, one would surmise that countries prefer to have positive net trade.  While sarcasm is not my style, I find it literally implausible that any person who resides in a country with a net import could argue that trade on such terms is a positive for them (if they are capable of self sustenance, i.e. not lacking sufficient resources to maintain life). It's a drag the country's GDP and a threat to its national security.  After all, some of the worst threats to the economy of the United States has been the result of dependence on the import of foreign oil.

Now, I understand that a small number of elite finance, corporate multinationals and ultra wealthy would like to proliferate a belief that the United States should not protect itself in any manner when it comes to international trade. These arguments are based in self interest and selfishness.  They are not healthy arguments, and clearly not sound judgment for a country that aspires to be the world's super power.  That said, these voices are strong because they own the media sources, banks, and a number of our elected officials.  Regardless of their amplification, they are wrong.

Succinctly and logically put, saving per our purchases from cheap foreign labor is not worth having a country where middle class workers have no means to make a life for themselves.  

Now many argue unions are to blame for the lack of competitiveness in the American worker, and while there is much merit to this argument, it is collateral to the point.  I'm talking about keeping American dollars in America.  Currently, Asian and Middle Eastern Countries use our dollars to manipulate the values of their currencies so that they can continue to be net exporters to the United States.  With little to no importance on the global scale as consumers, the citizens of these countries suffer with their undervalued currency while their governments use the captured dollars for investment in stocks, bonds and commodities.  That's right, the countries themselves use our currency to corner markets, drive up commodity prices and control corporations.  

Americans thus suffer a self-inflicted punishment.  We need two incomes to raise a family and we lose the ability for upward mobility as globalization destroys our need for our own human capital.  It starts with manufacturing and soon it is service work, finance and engineering.  

The proper question is why suffer?  The elitist with no regard for our Nation say it "makes us stronger," but that's nonsense.  The reality is that we live in a country loaded with natural resources, the benefits of capital, and the massive infrastructure that reflects our wonderful experiment of capitalism.  We have it all.  

Unlike the Chinese, Japanese, Russians, Germans, Mexicans and Indians we don't need them to purchase our goods to survive.  We are the consumer and they are without recourse should we insist on fair terms of trade.  Any great leader knows that he or she has at their disposal the power and ability to dictate whatever terms they have the power to uphold and impose.  One for one (export for import), as Warren Buffet would declare, is within our reach by a simple declaration by the US that such a standard is the now necessary.  The United States has the strongest military and the power to enforce its will with little or no recourse.  Why allow the weak to become strong by eating our innards?  Why destroy our way of life while those of ambition and tactical advantage attempt to unseat us with our own weapons. 

 We need to wake up, and stop the leak.  We must remember a multinational corporation is not country, the United States is our Nation.  Further we must act now, while we still can enforce our will.  This disturbing trend could unseat our ability to dictate terms.  With every mutter of changing the dollar as the international currency, every balk at trade reform by net exporters, and every month of negative net exports we move closer to becoming irrelevant.

For a more in depth discussion on this topic please see: http://commoncentsdg.blogspot.com/2009/01/national-security-and-balancing-current.html

National Security and Balancing the Current Account Deficit

Believe it or not, most people under the age of 40 don't even know what the current account is, much less how dangerous carrying a deficit is to our personal safety and the safety of our country. The current account is very simply the difference between exports and imports into our country. In other words, when a country exports more than it imports, the country has a positive current account, or a net export. When its imports exceed its exports, the opposite is true.

Most people don't pay a lot of attention to where a good is produced, assembled and its parts originate. However, it is a massively important factor to the overall safety of a Nation. In fact, Bismarck was qouted as stating, "Free trade is the weapon of the strongest (Makers of Modern Strategy, from Machiavelli to the Nuclear Age pg 223)." When a good is traded, or exported from the producing nation for payment, a number of crucial items are captured, most significantly 1. Greater Purchasing Power for their Currency, 2. Jobs, 3. Production Capacity, 4. Control of Natural Resources, 5. The Deflating of the Purchasing Countries Currency, 5. A General Tactical Strengthening of their Position in the world.

First, the purchase of a widget by a citizen of the United States from a foreign country, for our example Foreignland, causes a boost to the currency of Foreignland. This boost is caused because the US citizen is foregiong dollars for a good. Since that good was originated in a foreign country, the dollars received as payment are traded for the currency of Foreignland to compensate its workers, managers and profit margins. This trading of dollars for Foreignland currency causes the demand for dollars to fall and the resulting demand for Foreignland currency to rise. This causes an appreciation in the currency of Foreignland relative to the dollar and thus gives residents of Foreignland greater purchasing power for goods in dollars (real estate, automobiles, clothing or DVDs). In a functioning free market trade, the appreciation in the currency of Foreignland from goods sold to the United States would eventually lead to a reverse in the money flow as dollars become cheap and therefore the jobs, manufacturing, and goods would soon be produced in the United States as it is now more cost effective to build those goods in the US.

No big deal right? Right. Except, once a country enjoys the jobs, production capacity, control of natural resources, and general tactical strength over the purchsing country they are reluctant to allow the natural reversion to occur. Instead, the exporting country does everything in its power to hold its currency low, thus capturing all the dollars from the trade, as well as, the jobs, natural resources, and tactical strength. A perfect example is China. China refuses to allow their currency to appreciate by refusing to allow its currency to be freely traded or exported out of the country. China represses the market further by demanding that any import or foreign corporation be partnered with a Chinese firm with no less than 50% ownership in order to do business within the country. This is neither a dishonest or dishonorable action, it is statesmanship, albeit at the expense of industrialized countries such as the U.S..

That said, such behavior is not conducive to a free market. It creates a manipulated market with the majority of the societal rewards of trade favoring the country willing to assert itself. The sad reality is that the United States over the passed two decades has taken measured steps to eradicate any governmental regulation on trade so as to proliferate such results. Whether a naive pipe dream of free marketeers, a calculated manipulation by the upper 3% of the United States population to enrich themselves off of artificially underpriced labor, or pure laziness this lack of oversight by the United States as an entity have allowed trade to hinder its citizens rather than enrich them.

Worst yet, because of the number of U.S. dollars the Chinese hold in reserve, China is a significant military threat to the United States and its empire. Twenty years ago, China had no capability to manuever in the world, no economic might to purchase modern military technology, and was little more than a decentralized region of impoverished people. China certainly was not militarily ambitous or sophisticated enough to shoot down United States' satellites as a show of force (which happened in the summer of 2008). The enrichment from the dollars of U.S. citizens, gave the Chinese this capability. The dollars have literally built a formidable threat on the global scene with its own identity, cares, interests and ambitions. With every additional dollar, they grow relatively stronger and the United States relatively weaker.

Jobs, are the second great benefit of being a net exporter. These jobs represent a standard of living and the general contentness of a population. It is a given that a population without work is one which is without stability. Ghandi once stated that, "Violence occurs when there is wealth and no work." Many others have highlighted that there is a general tendancy of the classes to war when the working class of that society is not sustainable in nature. The great growth of the United States from 1941-1990 was the result of a vibrant manufacturing base and an economy where those willing to work were always afforded that oppurtunity. Without the abundance and demand for work, a society will begin to destroy itself from within. Therefore, it is not an exaggeration to state that the ability to import unilaterily into a country, is the ability to poison it.

An importing country becomes enslaved by the exporting country as its population is literally dependant on those imports so that they can resell them for industry (see article "The Float," this blog) and consume them for their sustenance. The exporter, thus, has the capablity to use their goods as a weapon to kill industries dependant on them. This type of attack by trade is an efficient means of asserting one's sovereignty as it devastates the morale of a target nation without having to spend military capital.

Production Capacity follows the same logic as jobs, except that it deals directly with materials instead of human capital. A country's ability to produce atrophes as its production dwindles. Very simply, when a country slows production it sheds equipment, factories, supplies and fixtures used to produce goods. Over a prolonged period, that shedding results in a lack of capacity to "ramp up" if necessary. Manufacturing is massively important in war as supplies and the ability to produce weapons, tanks, carriers and general supplies is a major factor in winning or losing. If a country forgoes capacity in times of peace, a great possibility exists that the lead time to ramp up for war becomes prohibitively long. Least we forget, the American automotive industry were the heroes of WWII as they answered the call of President Roosevelt to build sufficient planes and tanks to forge an attack against the Nazis.

It could not be more eloquently put than how Alexander Hamilton wrote it in his text book, Report on Manufacturers, the goal is to promote such manufactures....

" as will tend to render the United States independant of foreign nations for military and other essential supplies. [N]ot only the wealth but the independence and security of a country appear to be materially connected with the prosperity of manufactures. Every nation, with a view to those great objects, ought to endeavor to possess within itself, all the essentials of national supply. These comprise the means of subsistence, habitation, clothing and defense."

The general concept Hamilton proved was that free and unmanaged trade was a concept that only could succeed if somone was naive enough to believe war was no longer a real threat to the Nation. Economists and business leaders alike refuse to acknowledge this reality as it does not fit easily into their models of measuring profit and loss. Common sense nonetheless would assert that being conquered would trump any competing economic interest or argument asserted from that community. Thus, the balancing act between the benefits of trading between two parties of differing competitive advantages and protecting the soundness of the Nation is the operative standard of judging the best course of policy for a Nation.

Strangely enough, the father of free market capitalism, Adam Smith in his Wealth of Nations maintained,"the first duty of the sovereign was that of protecting the society from violence and invasion of other independent societies." As war was inherent in the understanding of any concept during the late 1700s, Smith was in favor of governmental regulation of international trade when that trade reached a level that was detrimental to the Nation's ability to protect itself in the world. It was Smith who said, "defense is of much more importance than opulence." After all, what is the point of trading if the end result is a net loss of its a Nation's sovereignty.

Control of Natural Resources is along the same lines of production capacity, but with respect to a specified class of items. Over the passed seven years the United States has experienced a tremendous run-up in the costs of natural resources. A significant reason for this run-up, aside from the speculation and margin buying by Wall Street (the reason for the 2007 commodity bubble), is the idustrialization of third world countries. Countries, such as India, China, Vietnam and South Korea had very little demand for oil, gasoline, heating oil, lumber, steel and concrete in the past; however, now due to increased demand for goods produced in these countries a need has been created. This need combined with the general depreciation of the US dollar, as a result of being a net importer of goods, has sufficiently lowered the standard of living of Americans in that they must pay more for essential items leaving less discretionary income available.

Further, this flow of limited natural resources to net exporters to the United States puts the US at the mercy of such countries in a time of conflict or disaster as they control the flow of commodities. For example, how would the United States react if attacked by an independent sovereign and in need of natural resources such as oil, steel, sugar and rubber, but the costs associated with getting those goods was extremely expensive because of a demand in China.  As a result, the United States looks to borrow or negotiate with the Chinese to acquire these items. In this example, assume the Chinese find an alliance with the attacking sovereignty more beneficial than one with the U.S. as the U.S. is vulnerable and without recourse. What would the United States do? Attack? No, we don't have the necessary resources to sustain such an attack. Maybe we could appeal to the business community who so profited off this trade arrangement, would they freely finance the war? Could they even if they wanted to?

Add all the above together and one can easily surmise why a net exporter will gain tactical advantage in the world. Net exporters very simply hold the power to destabilize the importing country from both the interior and the exterior. Eliminating social stability by devaluing the importing country's currency, eroding their substantive work force (substantive jobs are those that actually create a good, see The Float, on this blog), depleting their ability to acquire natural resources, reducing their capacity to wage war and capturing the importing country's reserves of currency all serve to empower the net exporter in the long run. These factors in addition to the forging of new trade and defense alliances with other sovereigns, as the net exporter grows in wealth and stature in the world, create an identity and ability to achieve its own ambitions.

Once strong enough, the United States can only appeal to the newly formed industrialized nation's sense of morality and fair play to achieve fair terms in dealings with them. This situation is the result of a comedy of errors by the stronger country to allow this situation to occur. During the strongest and most prolific years of the Roman Empire, independent sovereigns were reduced in stature to client states of the Roman Empire. These client states were strong enough to withstand their own populations from revolting and strong enough to withstand attacks from nomadic tribes , but never strong enough to pose a threat to the Empire itself. In exchange for surrendering their sovereignty, these client states received a better standard of living and support in protecting their lands from outside attackers. For the citizens of a client state being absorbed under the influence of Rome was a "good deal." They enjoyed peace, relatively stable commerce and a stable life. That said, ambition and ideas of becoming independent were not possible. Its not immoral or dishonest, it is responsible use of power for the greatest good of the citizens of the Empire. After all, isn't the entire point of government to provide a system and framework so that the citizens enjoy the greatest standard of living possible?

What about the "free market?" The answer is: what about it? Many simple citizens forget, or never understood, the free market is merely a mechanism of creating wealth and a standard of living for the citizens of a Sovereign. The free market provides no security to the citizens and clearly cannot exist without, at a minimum, the enforcement of criminal and property laws by the Sovereign. The Sovereignty of a nation is not subservient to a market, but rather the opposite is true. For without a Sovereign, the market cannot functionally exist. On this rationale, a market that serves to weaken and over time jeopardize the ability of that Sovereign to effectively maintain its ability to impose its will on the international scene is a market in need of adjustment for over time it will destroy itself by the same token.

Is the United States doomed? No. Strong leadership could reverse the current trend and restore its prowess in the world. The United States still can be the defining empire in the world, but strong statesmanship on behalf of its elected officials is necessary. Those officials must defy the urge to "do nothing" and allow the status quo to continue. Taking action would certainly force these officials to put the interests of America as a Nation in front of the interests of many powerful lobbyists who will invariably attempt to maintain this course of action. That said, officials must serve their country and citizens as a whole first. In acting in the best interest of the Nation, these officials will actually best serve those lobbyists as well, as their wishes are short-sighted and not sustainable in nature.

After all, the United States must act now while it still can sustain itself without importers. The United States should take back the wealth gifted to these countries by demanding fair ratio of 1:1 exports to imports.  Trading partners who fail to abide by this standard must be punished. The U.S. must support this stance with the full might of its military if necessary. If this occurs, the United States will clearly stand once again as an unchallenged power able to achieve its own ends in the world, peace, charity and abundance.