Economics
All fall down
Aug 12th 2010, 18:25 by R.A. | WASHINGTON
THE Wall Street Journal recently noted:
A strong yen is giving Tokyo an awful headache. Beijing is adding to the problem. If things get worse, these old rivals could find themselves facing off in global currency markets.
China has ramped up its stockpiling of yen this year, snapping up $5.3 billion worth of the currency in June, Japan's Ministry of Finance reported Monday. China has already bought $20 billion worth of yen financial assets this year, almost five times as much as it did in the previous five years combined. That's making the yen even stronger than it otherwise would be.
Tim Duy worries about what this means:
Interestingly, to the extent that China makes a minor adjustment to the Dollar peg, authorities simply redirect some of those capital flows to Japan. Note that, arguably, Japan is the least capable of absorbing those flows. Seriously, Japan is the biggest basket case in the industrialized world (although US policymakers are sprinting to keep up).
Michael Pettis puts it this way:
The PBoC seems to be increasing its purchases of the yen, and that is causing the yen to rise. It is also causing very unwelcome weakness in the Japanese economy. Whenever people argue that the US wants and needs net Chinese investment in USG bonds, you should ask how that can possibly make sense when every country seems to be doing all it can to repel foreign capital inflows (or to increase their own net capital outflows, as in the case of China, Japan and Germany). The idea that the US or any other country "needs" foreign financing is total nonsense. Nearly every country in the world is trying to export capital and import demand. The world has no urgent need of capital. It needs consumption.
Consumption, it's understood, that should be coming from surplus countries, particularly China. Unfortunately, as Mr Pettis also says, economists in Asia are increasingly worried that China's growth slowdown isn't happening in quite the controlled manner Chinese leaders would like you to believe. Neither can China easily increase consumption anyway. Mr Pettis speculates that low consumption is fundamental to the Chinese growth model, and the share of consumption in Chinese activity can't rise unless growth slows considerably"”or unless Chinese authorities undertake a massive transfer of state wealth to households, as through an unlikely large-scale privatisation programme.
The scenario is a gloomy one. It's one in which most of the world's large economies are imbalanced and inflexible and spend their time fighting over a limited amount of global demand, eventually precipitating (one assumes) a broad trade conflict. But must things end up this way? The latest Economist takes a look at global currency movements and hints at the possibility of a different scenario:
A cheap currency is especially prized now, when aggregate demand in the rich world is so scarce and exports to emerging markets seem the best hope of economic salvation. Japan's finance minister has complained that the yen's recent moves are "somewhat one-sided". That kind of talk has spurred speculation that Japan's authorities may soon intervene to contain the yen's rise. But such action would spoil the rich world's efforts to persuade China to let its currency appreciate. It is perhaps more likely that the Bank of Japan and the ECB will follow the Fed's lead in extending (albeit modestly) its quantitative easing"”or risk a rising exchange rate.
The battle for a cheap currency may eventually cause transatlantic (and transpacific) tension: not everyone can push down their exchange rates at once. For now, though, the dollar holds the cheap-money prize.
Not everyone can push down their exchange rate at once, it's true. But if central banks seek to reduce the negative growth impact of a rising real exchange rate by increasing monetary expansion, then it's possible for everyone to win"”the attempt to win the battle over the limited pool of global demand will help reflate domestic economies. The situation is not unlike that in the Depression. Struggling economies progressively left the Gold Standard to prevent a costly loss of international competitiveness, but while it wasn't possible for every country to benefit from the devaluation associated with departure from gold, the end of the Gold Standard meant a freeing of monetary policy, which allowed economies to reflate and recover.
This scenario wouldn't obviate the need for structural reforms in China, America, and elsewhere. But as China's reticence to continue appreciating amid a global slowdown indicates, structural reform is easier when global growth is strong.
The danger is that central banks won't respond in this way. In that case, politicians will likely step in with their blunter instruments"”import restrictions, and other protectionist policies. It's too early to tell which way things are likely to go. But with trade gaps in surplus and deficit countries mounting, the issue may come to a head fairly soon.
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China understands only power. Talking is pointless. Only tariffs will get the message across.
"Struggling economies progressively left the Gold Standard to prevent a costly loss of international competitiveness,"
That's not how the gold standard worked. If you had a trade deficit with another country gold would leave your country for the trade surplus country. With less gold, the money supply would shrink, causing prices to fall and your good would become cheaper. Eventually cheaper products would beat out more expensive ones in international trade and your trade deficit would turn into a surplus.
But that's not how the gold standard worked in practice. Gold only limits the volume of paper dollars that the central bank can print. It doesn't limit credit expansion at all; never did and never will. Massive credit expansion is just as easy with a gold standard as it is with fiat money. The booms and busts of the past were caused by such credit expansion. So gold never limited the ability of central banks to expand the money supply via credit expansion. Countries left the gold standard because they didn't want gold leaving their country. It made them feel poorer.
"..but while it wasn't possible for every country to benefit from the devaluation associated with departure from gold, the end of the Gold Standard meant a freeing of monetary policy, which allowed economies to reflate and recover."
Strange, but for centuries before the Great D nations had no problems recovering from credit induced depressions while on a gold standard. Central bankers must have suddenly become very stupid during the Great D because they couldn't do the same.
Time for the U.S. to revive the idea of a trade voucher system, in which balanced trade will be achieved by tying the issuance of import vouchers to the value of exports. The only trick will be collectively choosing between Canadian/Venezuelan/Nigerian/Saudi oil, Chinese/Japanese/Korean/German manufactured products, or Central/South American produce. If the world wants to sell to us, they'll need to buy from us. And the Treasury will have to sort out the likely drop in foreign purchases of U.S. debt.
Fundamentalist, are you saying that in order for a gold standard to effectively balance international trade and fiscal deficits, we would also need to abolish fractional reserve banking?
In this blog, our correspondents consider the fluctuations in the world economy and the policies intended to produce more booms than busts.
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