Most American’s (including politicians) don’t know what a currency war is, why the media is focused on it, how world currencies are connected, how China is involved, or what the implications of such an economic war would be.
Why care?
If you’re an American who wants your job back, or who wants to keep your job, we as a country have to move up the value chain, and be a leader in global issues. We have to get our own house in order first, and learn a new place in the global economy because, to be blunt, our old place is no longer relevant.
The reality is that the US and China are inexplicably dependent upon each other. The idea that the US would interfere with China/US trade if they don’t let their currency appreciate is daft. Equally as silly is the notion that China would then dump a ton of US debt on the market in retaliation. Either move would hurt both countries – it’s like going back to the cold war days of threatening nuclear war – nobody wins so what’s the point.
In the meantime, countries like Brazil, who let their currency float more freely, run the risk of overheating when capital floods their boarders. They are then forced to resort to capital constraints in the form of higher taxes on foreign investors to slow the pace. But foreign investment is good for Brazil and good for the rest of the world because Brazil has a growing middle class, which is the lifeblood of the global economy.
Confused?
Join the crowd. There is plenty of good information in The Economist and the Financial Times on the subject. “How to Stop a Currency War!” was the lead article in The Economist Magazine a couple of weeks ago. But for the layperson it’s confusing, and, as a trained economist, even I have to read the articles twice.
It is incumbent on us to find ways to make these topics more accessible, and more visceral, to people outside of finance and economics. If we don’t, we become subject to politicians reverting to protectionism because they think it’s an easy ticket to getting elected, when they don’t fully understand the dire results of such policies. Protectionist policies will only bring results opposite to what we all want, which is a growing global economy.
A Little Currency Background
Global exchange rates need to fluctuate and interact properly with each other. To do so, they need an unbiased benchmark—something that can have a stabilizing effect across all currencies. Today, the US dollar is that benchmark in most cases, and that is proving to be problematic for the long-term.
Prior to the 1930s and the rapid emergence of US world dominance, the gold standard was the stabilizer. In the 1940s, under Roosevelt, the US dollar became a key reserve currency as it became more desirable than gold. Gold then went through a period of undervaluation, leading to Nixon’s decision to de-link the US dollar from gold in the 1970s.
The US dollar as the key reserve currency worked well until we arrived in the 21st century, when our dominance in the world become less significant and we began to show unexpected and dramatic signs of economic weakness.
When a country’s currency drops in value, it typically signals some combination of a lack of productivity, a lack of innovation in general, and a lack of competitiveness as compared to other countries. In the last 20 years US currency valuation has masked these very important warning signals because it was propped up as a reserve currency. As a result, the US now finds itself behind the curve and has yet to fully acknowledge its predicament, let alone fully engaging in its comeback.
That’s why a protectionist driven US unilateral currency war with China is absolutely the wrong approach to what is being touted as borderline currency manipulation. It would be a kin to going backwards in time, and we desperately need a forward-looking, 21st century plan that embraces globalization. Politicians should be focused less on China’s currency appreciation, and more on boosting innovation, emerging industries, and exports in general.
It’s a Multi-lateral Issue
Stabilizing global currency markets requires three critical actions that involve many countries, not simply the US and China.
1. Change: Make substantive changes to a system that only partially works by using a multi-lateral approach through the G-20. It’s time our global systems were updated to reflect the realities and the benefits of the 21st century global economy.
2. Rebalance: It is in everyone’s best interest to move significant amounts of the world’s capital toward emerging economies and away from indebted rich countries. That should also provide an incentive to the rich countries to pay off some debt, innovate, move up the value chain, and generally push the envelope to make room for progress in emerging economies.
3. Focus: Countries should focus more on the value they bring to the world than substantiating their place in the world through market manipulations. Creating value should bring sustainable demand, despite currency fluctuations.
It’s a small world
Globalization is no longer an option. The entire world, and nearly every economy, are inexorably linked. Global monetary relations significantly affect even the smallest business on Main Street USA. Understanding the intricacies of a global economy—particularly as it relates to global exchange rates—is critical to the growth of US companies, the US economy, and the global economy.
The global capital markets turn over $4 trillion daily in currency markets and the total global sovereign debt market is estimated to be somewhere around $34 trillion dollars. A large chuck of that currency and bond trading occurs between countries and each is affected by the others. Interference in open market forces by one country trying to create a local effect creates a counter-effect in other countries.
Make markets, not war!
As US citizens living in this interconnected world economy, we have a vested interest in electing officials with a strong willingness to show understanding and global leadership in the area of international economics. Yet many politicians seem to be promoting the reverse—protectionism—because that’s what they believe Americans want.
That’s a complete copout. Such politicians irresponsibly enact policy based on the lowest common denominator of understanding rather than what is right for the long-term interest of our country, economy, and citizens. They might be surprised to know that we’re a lot smarter than they realize. We know that by properly positioning ourselves for success, when the rest of the world expands and prospers, we will as well.
If politicians think that forcing China to let the renminbi appreciate will somehow create more jobs in the US, they are simply misinformed. Nor is it even possible for us to make such demands. In the opinion of many respected economists, export expansion is the best option for generating substantial growth in the US in the near term (see previous blog post for more on US growth). It’s impossible for the US to compete on cheap labor and an undervalued currency. So, how can we compete?
Creating jobs through products and services the rest of the world wants can only come from within our borders and from evoking more creative competitive and innovation business strategies. An expanding world economy means expanding markets for US goods and services. That’s the elemental link the politicians miss.
We should recognize that countries like China, whom we perceive to be a threat, are in fact birthing the world’s largest middle class of consumers. We need strategic leaders who recognize the issue is not a US vs China currency war, the issue is: What can we sell China and other emerging markets that no one else is offering?
Bellyaching about US consumers buying Chinese products won’t get jobs back. Competitive business strategies will. There is an opportunity here for the US to re-focus on creating attractive exports based on things like innovation of new products that attract investment, filling usability demand gaps at the bottom of the pyramid, and offering unbeatable ingenuity in the delivery of on-going services.
Retooling our industries and work forces into higher levels of value added manufacturing allows us to trade short-term pain for long-term gain. In 10 years, if they act NOW, rust belt cities like Detroit can be thriving hubs of manufacturing again, focused not on aging consumables, but on nano technologies, green energy, applied materials, and other innovative industries just now emerging.
If the US can make products highly usable and full of irresistible purpose, the buyers will be there regardless of what is happening in the currency markets. It doesn’t always have to boil down to price. The key is focusing on what we want to support in the world and who we want to be — as opposed to what we are against and whom we can blame for our troubles.
Rebalancing the World’s Capital
When value creation comes first, money will ultimately follow. It’s time for global capital to become far less speculative and far more connected to long-term objectives and strategies for global economic stability. Hopefully the evolution of finance will begin to reward creating and following value and purpose as opposed to simply following short-term gains. We’ll have to wait and see on that one.
Yet, as we have seen in Europe, the capital markets are finally realizing that traditionally “safe” developed economies (i.e. Greece, Ireland, Spain) can actually carry risks significantly greater than those in emerging economies. A shift in capital away from the traditional rich economies and toward the emerging economies underlies part of the pain the US is undergoing. This shift is necessary and contributes to a growing global middle class that will ultimately increase global consumption, and therefore benefit all.
The dance becomes how much should shift and when? When do the risks tilt back in the other direction as an emerging economy begins to overheat or doesn’t have the political stability or infrastructure to cope with the rate of growth? And how quickly can the developed world reinvent its competitive edge and begin to attract some of that capital back?
Focused on the Wrong Things
The relationships between one country’s currency to another’s can have large and sweeping impacts on capital and export markets. This is precisely why we see China reluctant to let the yuan’s value appreciate.
Appreciation of the yuan would have an adverse affect on China’s exports, a large driver in their economy (or so they believe). The best answer for China is to allow for controled appreciation over time and focusing on gaining more growth from domestic demand. Strategic multi-lateral pressure can be helpful. Demands from one country simply won’t work.
The best answer for the US is to focus on pathways to becoming more competitive and innovative. There are more ways to gain a competitive advantage in the export markets besides cheap labor and a cheap currency. We must ask ourselves: What can we do to use our gifts of freedom to continue to supply the world with some of its greatest insights and products and innovations?
To remain the leader of the developed world, it’s imperative that we use our ingenuity to continue to push the envelope on technology and progress. This is our largest advantage over China. China’s repression of its citizens and control of almost everything, in turn suppresses creativity, connectivity, innovation, and ingenuity . . . all essential ingredients for 21st century global success. China’s biggest threat is itself, not the West. The US and other advanced democratic economies should take full advantage of China’s current self-fulfilling inability to fully compete.
What’s next?
We can only address these problems together, not through unilateral sparring. Our best option for sorting out some of these disputes is to encourage the G20 finance ministers to set some basic codes of conduct around what can be perceived as currency manipulation. This week I was happy to learn that the G20 is making some headway in discussions and is willing to address the imbalance in the voting allocation at the IMF as part of the negotiations.
We live in a complex world. China, currency, and the state of the US economy are complex issues, with complex questions: Today, are politicians on both sides of the aisle trying to pacify US labor groups and the general population in the run up to elections? Are they engaged in some all bark and no bite rhetoric against China? Or are they trying to solve the real problem at hand—the sluggish US economy?
We need to understand issues, and hold leaders accountable, and say: If you’re not doing the right thing I’m voting for someone else. Global exchange rates are complex, but what the US needs to do is actually quite straightforward. If the only thing I convey in this blog post is the need for greater focus on the root issues facing America (not China’s currency exchange rates), then I will consider it a success. America has been the most innovative, forward-thinking, and exciting country in the world for over 2 centuries. We have always accomplished the seemingly impossible. Unless we quickly remember what makes us unique and use those talents to jump-start new products, services, and leadership the world needs, we risk loosing our greatness and trading it for ordinary. I said it was straightforward, not easy and not without a lot of hard work!
