Race to the bottom actually race to the top

Note:  The title should be premised with in the current extreme environment – I am not supporting the idea that we can have permanent income gains beyond potential from printing money, that would simply be inflationary.

A bunch of poppycock from Reuters on “currency wars” here.  I’ll let Scott Sumner discuss the fallacy here.

I have no idea where these guys are coming from.  A currency war causes everyone to lose?  Why is that Mr. Reich?  Because it leads to high inflation?  And what causes the high inflation?  Rising AD?  And what is the point of the fiscal stimulus you favor?  Higher AD?

Seriously, when people talk about “currency wars” do they recognise what the mechanism is that is used to lower the value of currency – well it is printing dollars.  If we truly do have “insufficient aggregate demand” this is what we want monetary authorities to be doing.  Far from being a “war” it is really co-operation …

Note:  The “imbalance view” stems from the relative exchange rates changing and prices being sticky – so that countries can sneakingly change their real exchange rate to favour exports or some such.  This structural issue is interesting – but criticising what seems to be a bunch of central banks loosening policy on these grounds misses the point.

Furthermore, lets not forget the impossible trinity here (*,*,*) – if we try to control the exchange rate we either lose control of the inflation rate, or we have to arbitrarily restrict capital flows (which is also costly – as by restricting capital flows the cost of capital will rise).  If we want to forget about the crisis and argue for a medium term strategic (arbitrary) fixed exchange rate target this is a separate issue to any near term “currency wars”.

Update:  Paul Krugman paints out the structural issue here.  Now note that the US and Europe could devalue, and they force China to devalue – so they all print more money and stimulate aggregate demand.  Ergo, we have a recovery.

The issue here is that the recovery is “unbalanced” because of the artificial shift in the relative prices faced by exporters/importers.  This issue existed before the economic crisis – and this is a trade issue.  However, the threats regarding this are as high as they have always been – I can’t remember a time that the US wasn’t trying to get China to shift its currency.

I would also note that if China is willing to lend its export income for a tiny (maybe even negative) rate of return to the countries buying its exports then it isn’t clear that they aren’t just f’ing themselves over to be honest …

  • Miguel Sanchez

    “Aggregate demand” is nothing more than a cover story. It’s clear that Western nations intend to inflate their way out of their debt burdens, since they’ve already realised that there’s no chance of earning their way out. The IMF chief economist is advocating higher inflation targets; the Fed is talking about engineering higher inflation in the future to make up for the low inflation today; the UK is simply in denial about the inflation that it already has.

    US bond yields at 2.4% is not a sign that the market is worried about deflation; it’s a sign that the Chinese government is willing to appropriate its people’s wealth and generate negative real returns on it.

    Oh, and there are always losers in a worldwide currency debasement, whether it’s competitive or coordinated. Go back to your post on intergenerational transfers.

  • http://www.tvhe.co.nz Matt Nolan

    @Miguel Sanchez

    “It’s clear that Western nations intend to inflate their way out of their debt burdens, since they’ve already realised that there’s no chance of earning their way out”

    Yar, I agree. However, the losers here are those that have lent not those who have borrowed – which is the impression that the article is giving.

    “US bond yields at 2.4% is not a sign that the market is worried about deflation; it’s a sign that the Chinese government is willing to appropriate its people’s wealth and generate negative real returns on it.”

    Also agreed, we are transferring wealth from them to “the West”.

    “Oh, and there are always losers in a worldwide currency debasement, whether it’s competitive or coordinated”

    Yar, as above.

    ““Aggregate demand” is nothing more than a cover story”

    I left the first sentence till last, as its the only bit I have a little bit of disagreement on.

    The large level of unemployment right now is not all structural – as a result, increasing near term demand to get unemployed resources producing will increase incomes – as a result of price stickiness, printing some $$$ is a method for doing this.

    As a result, “AD” is part of the issue – I completely agree with you on the transfer issue as well – but the AD issue is still important.

    In essence, this all seems like good stuff for NZ as well – which is why I get confused about the panic that seems to surround us.

  • Miguel Sanchez

    “However, the losers here are those that have lent not those who have borrowed – which is the impression that the article is giving.”

    Actually I think the article is saying the losers would be those countries who try to take the moral high ground on currency debasement, and end up responding through tariffs and capital controls instead. Even that’s not quite right; both sides lose when it come to trade/capital controls. I’m fairly relaxed that it won’t come to that point though – if you have to give up one of the impossible trinity, a debtor nation will always choose inflation.

    I agree that price stickiness is the issue. But the stickiest price of all is debt; aside from the tiny share that is inflation-indexed, it’s utterly inflexible (outside of default). The problem is that the US, UK and European governments are now carrying so much debt that even a return to full employment won’t be enough for them to earn their way out. That’s way I say that stimulating aggregate demand is a sideshow – the only way out in the long term is debasement and inflation.

  • http://www.tvhe.co.nz Matt Nolan

    @Miguel Sanchez

    “Actually I think the article is saying the losers would be those countries who try to take the moral high ground on currency debasement, and end up responding through tariffs and capital controls instead.”

    When did tariffs become a moral high ground! I don’t see us getting to that point – the threat of a trade war was a lot more urgent in 2009 methinks.

    “The problem is that the US, UK and European governments are now carrying so much debt that even a return to full employment won’t be enough for them to earn their way out. That’s way I say that stimulating aggregate demand is a sideshow – the only way out in the long term is debasement and inflation.”

    Ex post the degree of the stimulus on the basis of true AD management and the amount on the basis of inflating their way out of debt will be observable. Given that, the intrinsic cost of default should still fall on the debtor nations.

    And if they it doesn’t, we are pretty much saying that the countries that lent so freely during the past decade will suffer for not taking account of risk – to be honest I have little problem with this.

    If we start getting large levels of inflation in the medium term, when we know that we are rolling back towards potential, I will rail against it – but for now I think a focus on the short-term demand management element of these policies is justifiable. This is really one of the benefits of having independent monetary authorities that can respond quickly IMO.

  • Miguel Sanchez

    Hmmm, maybe “moral” is not quite the right word, but slapping tariffs on foreigners has an air of legitimacy that debasing your own currency doesn’t. Remember that until recent history tariffs were seen as a perfectly reasonable way for governments to raise revenue, given the relative difficulty of policing income taxes.

    “And if they it doesn’t, we are pretty much saying that the countries that lent so freely during the past decade will suffer for not taking account of risk – to be honest I have little problem with this.”

    The Chinese government might have a problem with this though. And they don’t really seem like a ‘forgive and forget’ sort of bunch.

  • http://www.tvhe.co.nz Matt Nolan

    @Miguel Sanchez

    “Remember that until recent history tariffs were seen as a perfectly reasonable way for governments to raise revenue, given the relative difficulty of policing income taxes.”

    Those bastards.

    “The Chinese government might have a problem with this though. And they don’t really seem like a ‘forgive and forget’ sort of bunch.”

    Ahhh, but if they are pegging their currency to everyone elses there currency relatively devalues as well – so it is only when inflation starts kicking in that they get irritated. So they don’t mind the AD businesses – it is just real interest rates.

    If we have truly independent central banks we shouldn’t need to worry about this. And if we don’t, this could be a constraining factor on government intervention to devalue their debt. Either way – I’m still happy as long as we don’t end up with a trade or military war.

  • Miguel Sanchez

    “Those bastards.”

    Steady on, it’s not that bad. In terms of efficiency, consumption tax > tariffs > income tax.

    “it is only when inflation starts kicking in that they get irritated”

    Definitely, because they are a nation of savers. And you’re right that it’s a matter of when, not if.

  • http://www.tvhe.co.nz Matt Nolan

    @Miguel Sanchez

    “Steady on, it’s not that bad. In terms of efficiency, consumption tax > tariffs > income tax.”

    Bastards is a gentle ribbing term – I use it to describe anything that is mildly irritating, such as a fly that just won’t leave the room.

    “And you’re right that it’s a matter of when, not if.”

    Hehe – nice twist on my words there.

    I have an unjustifiably high level of faith in the ability of our independent central banks to control inflationary pressures – the reason for this is that, when it doesn’t happen, I can immediately just blame them, rather than having to look for some other excuse ;)

  • Miguel Sanchez

    I also have great faith in the ability of central banks to control inflation – just not in the direction you’re thinking.

  • http://www.tvhe.co.nz Matt Nolan

    @Miguel Sanchez

    Awesome!!!

    No doubt it is going to be an exciting time – will give us plenty to write about ;)

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  • Miguel Sanchez

    Matt, I noticed that further back you said that global money printing could turn out to be a good thing for NZ. I could see it actually being a very bad thing for NZ (depending on our own policy response), but I’d like to hear your thoughts first.

  • http://www.tvhe.co.nz Matt Nolan

    @Miguel Sanchez

    Good in the sense that it drives the real interest rate down – which is nice since we are net debtors.

    Don’t get me wrong, global hyperinflation would be a fools game – were everyone loses. But in a situation of insufficient demand lower real interest rates help – and given our position as net debtors it also provides a positive income transfer relative to the counterfactual.

  • http://www.channelsurfing.net/ bob

    I have no idea where these guys are coming from. A currency war causes everyone to lose? Why is that Mr. Reich? Because it leads to high inflation? And what causes the high inflation? Rising AD? And what is the point of the fiscal stimulus you favor? Higher AD?