Thursday, October 21, 2010

Currency War – My Mom’s tougher than your mom

The current discussion about a Currency War gives me pause to think about how far we have come during my life. I am at the leading edge of the baby boom because my father had one thing on his mind when he jumped ship at the end of World War II. So while I didn’t really live during WWII I feel that I can claim a connection. That was a hot war and there was no question about the meaning of war and that we don’t want to do anything like that again. While I missed the Korean War by being too young, I was just perfect to join the US Air Force and was able to participate in Vietnam.  I swore to the medical officer during my draft physical that I had flat and very smelly feet, but that didn’t seem to deter them from inviting me to join. Those wars were nothing to replay again. I spent most of my enlistment in an air conditioned office but we all know the horrible outcomes that all sides suffered from in Korea and Vietnam.

Most of my life, however, was impacted by a cold war which pitted my home country against the Soviet Union. I recall being a teenage boy and looking south in the Miami sky on the day that Kennedy called Krushchev’s bluff – a little game of missile chicken near Cuba.  I was wishing that I was from a richer family that could afford to dig a fallout shelter in South Florida. That was no fun either and we were all relieved if not elated when the Soviet Union imploded. I remember a jubilant colleague telling me that we would now be in an era of peace. No more war! What a great feeling.

Of course, what neither he nor I really foresaw was how the cold war between two key giants froze the outward manifestations of hundreds of years of animosity in many places of the world. As the cold war disappeared from memory banks, we have seen increased levels of conflict in former Soviet Republics, the former Yugoslavia, the Middle East, and more. We couldn’t be farther from a world of peace! In some ways we are even worse off than we were during the Cold War.

In this present context we read about currency wars. My first reaction is that this currency stuff has no connection whatsoever with a war. I don’t know why the press describes it in those terms. Maybe it sells more soap? In fact, I am not even sure that I understand who the enemy is and how we would fight them. In international trade as in all forms of trade there is competition among the players and they each try to gain their shares of the pie. In a time of great economic uncertainty when the world economy is growing slowly it makes sense that every firm and every government will want to compete harder to keep from losing business.  While war does involve a form of competition, competition frequently exists without any hint of war – from here is one definition of war –“a conflict carried on by force of arms, as between nations or between parties within a nation; warfare, as by land, sea, or air.”

It is self-defeating to call trade competition a war even if there are elements of unfair competition and protectionism. It confuses people and you know how easy it is to confuse the people in our government!
In my last post I documented a trend in financial trading that when combined with our goods trade deficits makes it pretty clear why the value of the dollar has been falling. Add the Fed’s alleged policy of a new vigorous round of quantitative easing and you have even more pressure on the dollar to fall. In today’s world of global competition where many countries are VERY reliant on their exports – no self-respecting populist official can sit around drinking expensive imported beer and let their currency appreciate against the dollar. 

Holy cow –imagine the leaders in Brazil or Singapore or Japan drinking their Budweisers in their new hot Chevrolet Cobalts telling the folks at home that it would be great for world order if the dollar depreciated another 20%. And it’s not just the dollar. Recall that our friends in China like to peg their currency to the dollar. So when the dollar depreciates against most world currencies, the yuan is also depreciating again the yen and the won and the real and the Singapore dollar. Hmm – not only is the US seemingly getting a trade advantage, so is China. Now that gets my jets in an uproar and it makes me want to depreciate and I don’t even have a currency.

Okay – so back to war. Who are we going to fight here? Answer – no one. Put your Rocky dolls back in their holders and cool your jets. What we have here is a bout of international trade instability. And it is a unique bout. In past currency crises it was possible for enough nations to come together and decide it was a good time to work together to either appreciate or depreciate the dollar. But as I described above – that would not really fit the current situation because just about EVERYONE wants to depreciate. You can pine away all you want for a return to the gold standard or gold exchange standard – a time when exchange rates were largely fixed – but that ain’t gonna happen here either!

So what is the solution? First, quit calling this a war. Second, use common sense. There are fundamentals that are causing exchange rate problems. Fundamentals often take time to manifest and therefore it takes time to solve the problem. So don’t be in too much of a hurry. Third the US has to save more at home and spend less abroad. That will help reduce the downward pressure on the dollar. Fourth, the Chinese need to save less and spend more at home and that will reduce their need to rely on exports. That will make it easier for them to tolerate a yuan appreciation. As the dollar rises this will take some pressure off the need to have the Yuan fall and the other countries will be able to let their currencies float without harm.

You can call it a war and you can scream that you want the government to fight for your country’s exports, but none of that is going to do a thing in the face of real and fundamental international trends and cycles. A string of competitive devaluations or other forms of export protection will do nothing but exacerbate the problems. “My mom is meaner than your mom” just gets flung back in your face squared. Once people begin to see China, the US, Germany, Korea, and other countries addressing the real causes of trade imbalances then you will see this exchange rate issue diminish. Until then, let’s hope Obama doesn’t jump in the ring with a sumo wrestler or a Chinese bear.


  1. I have long argued that Korea changed the definition of the word war. There was a famous MacArthur letter critical of Truman stating "we fight Europe’s war with arms while the diplomats there still fight it with words". Earlier Truman had ordered MacArthur to only bomb the Southern half of a bridge on the Yalu (over which enemy troops were entering South Korea), since China claimed it would enter the war if the Yalu was crossed. MacArthur responded in all the military training he had (including graduating first in his class at West Point) he had never been taught how to bomb only half a bridge.

    While I was also not involved in WWII I have discussed it with my Dad who was. One thing that always bothered him about VietNam (it bothers me as well) was what we both called the "only bombing half a bridge in a war" position.

    So maybe we need to redefine war to also include currency manipulation.


  2. Good point but I am not ready to call currency manipulation war...maybe we will get half a currency manipulation. What would we call that?

  3. The use of the words "Currency Wars" allows everybody to blame somebody else for the problems they are facing. It also makes it easy to convince the voting public that the problem is not at their door steps.

  4. So, how do you feel about a common world currency?

  5. I suspect it is a long way off.