Photo Credit: Medill DC/Flickr
By Bill Wilson — Speaking in Tokyo where the International Monetary Fund (IMF) and the World Bank held annual meetings on Oct. 14, 2012, Federal Reserve Chairman Ben Bernanke pleaded with emerging economy central banks to let their currencies appreciate.
He even did it with a straight face — no small feat as the U.S. has embarked on its most ambitious campaign to date to devalue the dollar with $480 billion of quantitative easing every year from now on.
“In some emerging markets, policy makers have chosen to systematically resist currency appreciation as a means of promoting exports and domestic growth,” Bernanke charged.
Of course. What else does Bernanke expect emerging economies like China or Brazil to do? Allow the prices for their own exports to rise with impunity?
Retaliation is to be expected. It is a trade war, after all.
Unlike the Smoot-Hawley brand of slapping direct tariffs on imports, Fed policies to depreciate the U.S. dollar make exports relatively cheaper and imports more expensive, presumably helping U.S. firms to gain a global edge.
In that sense, Bernanke has done nothing to encourage other countries to keep the values of their currencies steady, let alone to appreciate. He has nothing to offer them.
To the contrary, a falling dollar — the world’s reserve currency — encourages other countries to depreciate their currencies in response to keep exchange rates stable, creating a vicious debasement cycle.
Nonetheless, Bernanke tried to persuade the developing world to appreciate their currencies anyway, arguing that “monetary easing that supports the recovery in the advanced economies should stimulate trade and boost growth in emerging market economies as well.”
Here, Bernanke is suggesting that if U.S. exports are assisted by a weak dollar, inflows will boost consumption here, and that in turn will help emerging economies as we purchase more imports.
There is only one problem. It hasn’t happened despite four years of quantitative easing.
According to data published by the IMF, exports worldwide are down in 2012 by an annualized rate of 1.8 percent, led by a 2.6 decrease in emerging and developing economies.
Put another way, worldwide exports in 2011 totaled $18.024 trillion. But in 2012, at their current pace, will only total $17.686 trillion, signaling a significant slowdown. This would mark the first such contraction since 2009.
In that context, Bernanke’s currency war is actually hurting global trade. Which is exactly what happened in the 1930s after the passage of the Smoot-Hawley Act. Trading partners like Canada and Great Britain responded with punitive tariffs on U.S goods. As a result, global trade contracted worldwide.
Meanwhile, while the weaker dollar has seemingly boosted exports, it has done nothing to reduce the trade deficit, which has actually widened on the heels of higher oil prices. That makes the biggest winner of the current situation oil exporters.
In fact, the trade deficit has increased every year since 2009, and at its current rate will come in at $741 billion for 2012 based on data compiled by the U.S. Census Bureau, $14 billion more than last year.
In summary, competitive currency depreciation has not promoted global trade — it’s actually sparked a trade war — and it has worsened the trade deficit. If allowed to continue, the policy will eventually hurt U.S. exports as the world spins back into recession. So, what’s the point?
Besides, if emerging economies were to appreciate their currencies in this environment, it would crush their export models as prices rose. U.S. consumers would buy less of their goods, not more.
If Bernanke really wanted to encourage emerging economies to appreciate their currencies, he would embark on a strong dollar policy instead of debasing the currency. China’s yuan is on a fixed exchange rate with the dollar. Appreciation here would lead to appreciation there. Meanwhile, lower producer costs would have a stimulative effect, incentivizing job creation and production here in the U.S.
The side effect would be an inability to finance our fiscal deficits at lower-than-justified interest rates. In other words, we’d have to cut spending on the federal level and reduce our debt load through repayment. Would it hurt in the short run?
You bet. So does a drug addict attempting to go sober.
The IMF recently adjusted upwards its so-called fiscal multiplier model — a measure of the impact of fiscal spending levels on economic output — suggesting that the immediate, negative impact on economic growth produced by spending cuts is higher than previously thought.
So, in the short-term, the impact of austerity on a debt-strapped nation is recession — which is not really that surprising. The government sector is necessarily contracting because a country’s debt burden has become unsustainable. This results in temporary rises of unemployment as government workers are laid off.
But small cuts on the margins — such as being attempted in Spain, Greece, and Ireland — are not enough to produce the desired outcome.
Unless nations undergoing such policies significantly reduce aggregate debt levels — either through a repayment plan or default — they may just be treading water.
In the long-run, lower debt levels will free up capital for the private sector, leading to real growth. This will make weak currencies — which in advanced economies are really designed to finance fiscal deficits, not promote trade — unnecessary, interdicting Bernanke’s currency war and restoring real value to global trade.
Bill Wilson is the President of Americans for Limited Government. You can follow Bill on Twitter at @BillWilsonALG.
