Thursday, October 6, 2011

Forex Markets and American Competitiveness

I originally got the idea for the blog at 3CNB because I was emailing a few friends so voluminously about questions of economics that it made more sense to do the thing publicly where everybody could see it than privately.  I got into the habit again, and do not have time this week for a fully composed post, so here is a recent one concerning the question of why regulations do not matter very much in terms of international competitiveness.  I apologize in advance for the lack of formality and rough language, but I do not think it is worth trying to fix.

Background:  we were discussing why there are no catfish restaurants at a particular reservoir outside of Dallas, Texas, which eventually led me to explain why I thought that almost all of America's supposed lack of international competitiveness was due to monetary causes and was totally corrupted, such that it doesn't really matter who is more productive or efficient or 'cheaper', and not from regulations as almost everyone seems to think.


The exchange rate manipulation thing is so insanely complicated that I don't think I have even understood some small fraction of it yet, but basically what I do understand goes as follows--

It is a very easy thing to 'encourage exports.'  The first thing to do is to tax everything coming in, or otherwise erect trade barriers towards imports.  But you know that.  What follows after that is a long chain of interventions.  Each act creates other incentives and necessary acts just to keep the ball rolling that you've already started.  But of course, once you've got the ball rolling, you create dependencies, just like with other welfarist type activities and inflation.  Things just get worse and worse and ever more outrageous things must be done to keep it going, until eventually you wind up with a situation like ours which is completely asinine.  As for those other incentives, many other nefarious activities have gotten wound up in the enormous cash flows that the process of manipulation generates -- chief among them, America's outrageously bloated government and deficits.

If you really want to understand the consequences of international trade on current account flows under different monetary regimes, check out Monetary Nationalism by F. A. Hayek, which can be found as part of Prices and Production and Other Works.  Anyway, it's free, and it taught me a lot of things, even though I already knew quite a bit about it.  But it is not that easy to read.  He talks about 3 different regimes -- an ideal hard money regime that has never existed, the 19th century so-called gold standard (which was actually quite bad in this regard, as he describes), and 'monetary nationalism,' a fiat money scheme that did not exist at the time he wrote it, but was being contemplated and is basically what we have today.  The fiat system with floating exchange rates arose to 'fix' the problems that were occurring under the gold standard, but they did so by severing the processes that hold the system to a basic level of account, which had the consequence that the new system would be easier to game and send into complete chaos.

Basically, because under the gold standard you still had the monetary pyramiding effect (m1, M2, etc.), whenever one nation ran a trade deficit, the dollars (M1 or M2) that wound up in the foreign country would be redeemed for gold (monetary base), since dollars were useless to the exporter but gold was useful.  So, trade deficits had the effect of shrinking the monetary base -- which had a multiplying effect on the rest of the money supply because of the pyramiding!  There was an exponential destruction of money relative to the actual money transferred.  The gold exporting country would have a credit contraction and depression, while the importing nation would experience credit fueled boom (since it got new monetary base to pyramid off of).  This is, of course, totally wacko, creating all sorts of bizarre consequences that have nothing to do with any real economics, i.e. it is all a purely monetary effect, simply as the result of one company in one country realizing a competitive advantage over its competitors in another.  Or because of some other effect which caused a temporary trade deficit, like tariffs.

Floating exchange rates were meant to mitigate that effect.  Instead of a huge transfer of monetary base, your money stayed put but became worth a bit less, which encouraged goods to flow the opposite direction and alleviate the deficits.  Unfortunately, it should be obvious that even if this might possibly be a less bad effect, it is still totally wacko -- why should an exporter in the US, say, suddenly and completely randomly have a competitive advantage because of the success of a totally unrelated Chinese exporter?  What does that have to do with anything economically?  Nothing.  It is purely a monetary effect.  On top of that, changes in currency exchange rates create changes in the value of capital in different locations which again have nothing to do with anything in the real world.  A whole new high-volume 'market' in international capital transfers was created and populated by traders like George Soros et. al., in which people began making fortunes on, basically, imaginary figments of money systems that have nothing to do with anything real.

Governments (like China's) also found that they could still have their cake and eat it too as far as mercantilism is concerned.  They can undermine the whole point of floating exchange and keep their currency at a certain exchange rate with foreigners simply by artificially providing a 'back transaction' to balance exports.  Their government and central banks buy financial assets in the US to keep their currency at an exchange rate that favors the export of goods to the US.  Once again, the money system was fueling behaviors that have no connection to reality -- demand for something (US Treasury debt and other financial assets) regardless of price on the basis of its 'financial accounting location' and benefits conferred to favored industries by manipulating international capital flows. 

Other governments (like the US) found that, by allowing mercantilists to play their games, they could get extremely cheap financing for their bread-and-circus boondoggles.  They could run more or less perpetual deficits without any negative consequence, so long as foreign exporters controlled mercantilist foreign governments and prodded them to purchase these financial assets.  They ran up huge debts for decades and decades, addicting vested interests within their countries to free government stuff, creating a proliferation of political nasties, buying off enemies, papering over decay, and spreading virulent and caustic attitudes.

Domestic manufacturers (mostly located in places like the US) found that, rather than being wiped out by the foreign mercantilists, they could join in the feeding frenzy by moving offshore.  By hooking up and playing along with the corrupt governments involved, they got in on the very lucrative, very destructive game.  With time, they have insinuated themselves into the very systems that caused them to offshore in the first place, and now have become powerful vested interests in seeing the thing perpetuated indefinitely.

The normal 'equilibrating' forces that most people assume will iron these things out and bring them into a balance that reflects reality are never allowed to do their work.  Equilibrium is never reached -- the policies and actions of these groups are designed to ensure that.  It is equilibrium that is laying waste to markets today, and equilibrium that the banks and governments are fighting off.  If equilibrium were ever reached, and financial accounting ever allowed to reflect reality, the powers that be would be destroyed. 

All of this, purely monetary figments.  Nothing related to reality.  Trillions of dollars of goods, services, and financial transactions, year after year, with precisely zero connection to anything in the real world.  Anyone who defends this, or the Wall Street clowns and their ilk in foreign financial cesspools, profiting by parasitizing the brainwashed and corrupted and the innocent alike, is an idiot.  Anyone who understands and defends it is evil.  That is what I mean.  It is not efficient, it is not wealth creating, it has none of the qualities its apologists ascribe to it, it has no connection to economic reality.  It is a racket written into law for the benefit of glorified thieves and it is disgusting.

And yet, people blame regulations for the perceived uncompetitiveness of American industry.  Obviously, regulations, however stupid and egregious they may be, are only a minor nuisance in comparison, and in the long run, they can never actually create imbalances.  That is just the nature of the beast, the way it works, but not many people understand it.


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