A very good article here that comes closer than most to what I consider the crunch issue.
The key point is that if a currency moves down so that imports become ‘more expensive’, then the ‘inflation’ that goes off is a distributional response that tries to eliminate some of those imports so that the exchange demands equalise. That also eliminates somebody else’s exports.
The important thing to remember is that when a currency goes down, all the others in the world go up in relation to it and nations that rely upon exports (export led nations) start to lose trade - which depresses their own economy.
Any one of those other economies can intervene in the foreign exchange markets, purchase the ‘spare’ currency and that will halt the slide for everybody. And all exporters to an import nation have a central bank with infinite capacity to do that.
Export-led nations have to constantly provide liquidity into the rest of the world to allow others to buy their goods. Otherwise the rest of the world runs out of the particular money that is needed for the export transaction to complete and the export never happens (UK buyers buy Chinese goods with GBP, but Chinese workers are paid in Yuan. The relative shortage of Yuan due to the export differential has to be provided by the Chinese or Chinese goods become, in absurdum, infinitely expensive).
So the important insight, IMV, is that exporters need to export and the central banks that support that policy with ‘liquidity operations’ will ultimately halt any slide for any important export destination - either explicitly or implicitly through their own banking system.
Every analysis I’ve seen analyses the situation from the point of view of the currency that is being depressed. Almost none look at it from the exporter’s point of view. So where are the goods they no longer can sell to the importer going to go in a world where overall export growth is fundamentally limited by the increase in world income? In a world where ‘export led growth’ is the insane mantra, that is a mistake and leads to a mistaken view and mistaken policy recommendations.
So its a bit like borrowing from a bank. If you import a little then the exporters own you. If you import a lot then you own the exporters - because they then have nowhere else to go.
The shift to manufacturing in the 3rd world has generated a huge export overhang with the West. They need to export to the West or their economies collapse. And that is one of the reasons why the Western currencies have remained valuable - because the Eastern countries are forced to run up huge stockpiles of the stuff to enable their economies to work.
And that will continue until they realise they are being had, eliminate the export overhang and move to domestic consumption. You’ll note that the Japanese have only just done that, so it ain’t something that is going to happen overnight.
For me the policy response to sliding currencies is to control the distributional inflation by temporarily banning the import of ‘luxury’ items. That forces the problem onto the exporters, which they can relieve by systemically intervening and fixing the currency imbalance. Forcing them to do what they normally do through the course of trade.
No country has an automatic right to import any more than it exports. The corollary to that is that no country has an automatic right to export more than it imports. It has to buy that right - either by stockpiling foreign financial assets or by convincing a bunch of dumb countries into a monetary union so that it can export its unemployment to them - cf. Ecuador vs. USA, Greece vs. Germany and arguably Scotland, Wales and Northern Ireland vs. England.
So let’s stop looking at this problem from the wrong end.
It’s the exporters stupid.
First published - 24 Feb 2014