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<font face="Verdana" size="1" color="#002864">http://www.mises.org/fullstory.asp?control=1426</font>
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<font size="2"><font face="Verdana" color="#002864" size="5"><strong>Currency Wars</strong></font>
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<p class="MsoBodyText"><font face="Verdana" size="4">By Sean Corrigan</font>
<p class="MsoBodyText"><font face="Verdana">[Posted January 22, 2004]</font>
<p class="MsoBodyText"><font face="Verdana"><img alt src="http://www.mises.org/images3/fallingdollar.gif" align="right" border="0" width="177" height="349">We
have seen the temperature rise along the corridors of power in recent days as
finance ministers, central bankers, and others have clamored to have their say
on the current disruption in international capital and goods markets. This
disruption has its roots in America's Military Keynesianism and the Asian
Mercantilist response it has elicited.</font>
<p class="MsoBodyText"><font face="Verdana">For example, much has been made of
the fact that ECB chief Jean-Claude Trichet—Chairman of the central banker's
cabal, the Group of Ten—said, somewhat tautologously, that"excessive
volatility" and"brutal moves" in currencies were"inappropriate."</font>
<p class="MsoBodyText"><font face="Verdana">Undoubtedly, some Euro politicians
are keen to go a step further and secure an agreement on a schedule of joint
interventions at February's G7 meeting, but it seems highly unlikely that Karl
Rove would act to annoy the domestic industrial lobby in an election year, or
that the US neocons would cooperate to alleviate any Gallic misfortune.</font>
<p class="MsoBodyText"><font face="Verdana">Rather, Trichet seems to be
offering a coded warning that while the central banks will not give the
markets a definite target at which to aim, dollar bears—who have only
learned to scorn all the Bank of Japan's billions this year—should not
reckon on an uninterrupted reign, especially if the dollar's decline becomes,
in a buzzword,"disorderly."</font>
<p class="MsoBodyText"><font face="Verdana">Indeed, Trichet's replacement at
the Banque de France and former ECB VP, Christian Noyer, largely confirmed
this view when he told France 2 TV: "We shouldn't over-dramatize
this problem with the dollar. If you ask an American what a dollar is worth,
he will say it's worth a dollar. In the same way, we Europeans must say that a
euro is worth a euro."</font>
<p class="MsoBodyText"><font face="Verdana">He went on to add that it was
"true that very sudden moves between the biggest currencies are never
good for global growth" before he obliquely blamed Washington with his
injunction that"all those concerned need to ensure, as far as they can,
the maximum stability between currencies, by having well-conducted monetary
policy for central banks and budget policy for governments."</font>
<p class="MsoBodyText"><font face="Verdana">In fact, Noyer received a little
unexpected support from Japanese Finance Minister Sadakazu Tanigaki, who—in
a rare display of backbone when dealing with the occupying power—told a
Tokyo press conference,"We will have to ask the US to do something about
its twin deficits," since these have been"cited as a source of
concern in the currency markets."</font>
<p class="MsoBodyText"><font face="Verdana">Asked if the ECB would buy dollars
to halt the euro's gains, Noyer responded half-heartedly that"intervention
is something that's always available as a policy tool for the central bank,"
but this was, naturally,"never announced in advance."</font>
<p class="MsoBodyText"><font face="Verdana">Though calls for"something
to be done" grow increasingly vociferous, Italian European Union Affairs
Minister Rocco Buttiglione echoed the views of many in blending a note of
resignation on the chances of meaningful success through foreign exchange
manipulation with a call for an offsetting rate cut: "What effect
do interventions to sell currencies have? Can they really stop such a strong
market trend? I don't think so." …"[But] we have interest rates
that are significantly higher than those of the dollar. Lower interest rates
wouldn't hurt, especially in a moment like this one."</font>
<p class="MsoBodyText"><font face="Verdana">Dealing with just this point,
Noyer limited himself to observing that"The ECB's interest-rate policy
is never decided by one thing alone, such as the exchange rate."</font>
<p class="MsoBodyText"><font face="Verdana">Though politics may yet trump
sound economics on this issue, the Europeans know they are being blackmailed
by the US into pursuing dangerously loose monetary policy (to add to the loose
fiscal policies already being practiced by some of their governments).</font>
<p class="MsoBodyText"><font face="Verdana">Thus it has ever been, from the
1944 Bretton Woods agreement through the numerical mish-mash of G-5s, 7s, 8s,
10s and 20s and so on (note the inflation at work here, too!) in the floating
exchange rate era that has held since 1973.</font>
<p class="MsoBodyText"><font face="Verdana">The biggest global spendthrift—usually
the US—always expects his creditors to cut their own pockets so he can
settle his bills with the coins falling out of them.</font>
<p class="MsoBodyText"><font face="Verdana">To see what the ECB really thinks
of this, listen to what its Chief Economist, former Bundesbank bruiser Otmar
Issing told VWD, a major German newswire: "The best contribution
the Euro Zone could make in lessening world imbalances is to foster durable
and inflation-free economic growth."</font>
<p class="MsoBodyText"><font face="Verdana">Issing cautioned that the
G-7-Finance ministers and central bank governors should not"consider
creating an artificial bubble of demand through expansive financial and
monetary policy," for,"from such a momentary flame, little can be
expected but more inflation."</font>
<p class="MsoBodyText"><font face="Verdana">Indeed, he went on, the world
economy already has"sufficient bad experience of such initiatives,"
most notably in late 1980s Japan where"the wrong policy was pursued and
the bubble only strengthened, from the consequences of which—the ensuing
collapse of both property and equity markets—the Japanese economy suffers to
this day."</font>
<p class="MsoBodyText"><font face="Verdana">This is a lesson completely lost
on today's Fed.</font>
<p class="MsoBodyText"><font face="Verdana">Greenspan was at his smug,
infuriating best recently in arguing that the US external deficits were not
yet a problem, as there is"little evidence of stress in funding U.S.
current account deficits" partly because inflation,"the typical
symptom of a weak currency, appears quiescent."</font>
<p class="MsoBodyText"><font face="Verdana">Hmmm. With export prices now
rising at their fastest in over eight years; with core crude PPI up by a third
in just two years; with unfinished import prices up 20% in that time; and with
finished import prices up 6.7% annualized since the start of spring—again,
nearly a 9-year high—that quiescence must be limited to the registers to
which Greenspan chooses to listen.</font>
<p class="MsoBodyText"><font face="Verdana">And with his usual circularity in
relying for justification on signals generated by the actions of those very
same financial market participants who can frequently either be misled by, or
can choose to exploit, the Fed's own prior willfulness, Greenspan can hear no
Cassandras warning of the Greeks inside the Horse:</font>
<p class="MsoBodyText"><font face="Verdana">"Inflation premiums embedded
in long-term interest rates apparently have fluctuated in a relatively narrow
range since early 2002. More generally, the vast savings transfer has occurred
without measurable disruption to the balance of international finance... credit
risk spreads have fallen, and equity prices have risen, throughout much of the
global economy."</font>
<p class="MsoBodyText"><font face="Verdana">Adding another two cents' worth,
his colleague Mark Olson—equally sanguine about events overall—also
displayed a hint of cynicism when he noted that the <ST1:COUNTRY-REGION>
<ST1:PLACE>
US</ST1:PLACE>
</ST1:COUNTRY-REGION>
owed so much, it would never have to pay up (or words to that effect). As
Reuters reported it:</font>
<p class="MsoBodyText"><font face="Verdana">"[Olson] saw no problem with
relying on foreign investors for its finance. 'There's always some risk there,
but if seems to us that it is not a significant risk,' he said, noting that <ST1:COUNTRY-REGION>
<ST1:PLACE>
China</ST1:PLACE>
</ST1:COUNTRY-REGION>
and <ST1:COUNTRY-REGION>
<ST1:PLACE>
Japan</ST1:PLACE>
</ST1:COUNTRY-REGION>
rely heavily on <ST1:COUNTRY-REGION>
<ST1:PLACE>
U.S.</ST1:PLACE>
</ST1:COUNTRY-REGION>
debt instruments. 'It doesn't seem to us that that is an immediate threat.'"</font>
<p class="MsoBodyText"><font face="Verdana">Even the normally level-headed
Cleveland Fed President, Susan Pianalto, displayed a similar level of
insouciance, remarking,"Given a broad measure of the dollar's movement,
it's declined by about 14 percent since its peak. There have been larger
declines. So far the depreciation has been orderly. It's difficult to know why
the dollar is depreciating."</font>
<p class="MsoBodyText"><font face="Verdana">There are one or two people who
can clue you in as to why, Susan, if you really can't work it out for yourself!</font>
<p class="MsoBodyText"><font face="Verdana">But if <ST1:PLACE>
Europe</ST1:PLACE>
is the region feeling most of the strain of Washington's inflationary
blackmail, are there at least any prospects that the Americans might do less
harm than good, at least domestically, and so give the lie to Issing's
admonitions to them?</font>
<p class="MsoBodyText"><font face="Verdana">To see what we think of this, let
us bring two disparate quotes together and draw what seems the inescapable
conclusion from them.</font>
<p class="MsoBodyText"><font face="Verdana">First, Ms. Pianalto: "We
are in the third year of an economic recovery, but the lack of employment
growth has made this a very unusual recovery. Unfortunately, employment growth
in this phase of the current cycle is the slowest in 50 years, a situation
that remains something of a puzzle. Businesses often require some time to
restructure their operations to take advantage of new technologies. In the
process, we may find that there is a mismatch between the skills required by
sectors of the economy that are growing and the skills of our current labor
force. The very slow growth in employment that we are seeing could be
indicative of this type of restructuring, even while other indicators of
economic activity appear satisfactory."</font>
<p class="MsoBodyText"><font face="Verdana">Then this from South Korea, where
the world's fourth largest steel maker, Posco, was sharing its outlook for
2004 and was warning that operating profits might only rise by around 4% this
year, in contrast to last year's 67%.</font>
<p class="MsoBodyText"><font face="Verdana">But how can this be? If world
demand for steel is stronger and prices are rising as a result, why is profit
growth likely to be so meager?</font>
<p class="MsoBodyText"><font face="Verdana">Because, as Posco Chairman Lee Ku
Taek told analysts and investors: "What matters for steelmakers this
year will be how to secure enough raw material rather than how much more they
have to pay for it. There may be some Chinese steelmakers that will be forced
to stop operations after failing to secure raw material."</font>
<p class="MsoBodyText"><font face="Verdana">The two inferences to be drawn
from this are first, as Pianalto correctly points out, if there is a mismatch
between the skills available in the labor market and the ability to satisfy a
given demand, only a painful process of readjustment, relocation, and
retraining can help redeploy the people endowed with them.</font>
<p class="MsoBodyText"><font face="Verdana">If this is true of jobs, it is
true of the businesses which gave rise to those jobs: If productive capacity
and capital in general have been wrongly structured or malinvested—even if
this becomes apparent only in hindsight—these too must be redirected,
reassembled, or scrapped altogether.</font>
<p class="MsoBodyText"><font face="Verdana">It should thus be obvious that no
amount of blind monetary inflation or fiscal activism can do more than delay
or disguise the reality of the need to move and restructure substantial
resources.</font>
<p class="MsoBodyText"><font face="Verdana">Second, as the Posco example shows,
the result of most such attempts at"stimulus" is often not to
promote activity in those areas where capital and labor have been
over-invested in the boom—and which may be widespread enough to depress the
statistical aggregates on which the mainstream fixates—but, conversely, to
reveal where there is all too real a shortage of specific capacity, a
deficiency that the extra stimulus will transform into an inflationary
bottleneck and an impediment to structural change.</font>
<p class="MsoBodyText"><font face="Verdana">What the Posco example also shows
us is the verity of John Stuart Mill's principle that"the demand for
commodities is not the demand for labor"—something the grasp of which,
Hayek contended, was the test of true economic insight. For here, because of
differing elasticities of demand and the varying uses that come into play at
either end of the production process, the rising price of raw materials is
serving only to raise the steelmakers' input costs more rapidly than they can
increase their prices.</font>
<p class="MsoBodyText"><font face="Verdana">The underlying meaning here is
critical: The indiscriminate provision of extra"purchasing
power," or the artificial boosting of"effective demand," is
inimical to heightened returns on capital, and hence to increases in income,
jobs, investment, and further material progress.</font>
<p class="MsoBodyText"><font face="Verdana">Inflation is no panacea, and even
when it does help—in rare times of such a deep dislocation of production and
consumption that monetary factors are compounding real side woes—it is
arguable whether simply addressing those real side factors with proper
dispatch and with no concessions to vested political interests might not
effect a more well-founded and equally rapid recovery.</font>
<p class="MsoBodyText"><font face="Verdana">Yes, Greenspan was right to note
that economic"flexibility" is needed for the shock of the rough
times ahead. This is, after all, simply another way of describing the
oft-repeated calls for"structural reform" for the reliance upon
which the much less inflationist ECB has so often been derided by the
Anglo-American Avatars of Easy Money.</font>
<p class="MsoBodyText"><font face="Verdana">Where Greenspan is wrong—foolishly,
hubristically, perilously wrong—is in his assumption that the hegemony
exercised today in the US by big government, legal vulturism, organized labor,
corporatist militarism, and Marxist miseducation over entrepreneurship has
left the economy with enough of this essential flexibility. The US may someday
find itself unable to cope with the frictions and stresses of rapidly changing
circumstances with which it inevitably will be confronted.</font>
<p class="MsoBodyText"><font face="Verdana">Where he is also wrong is in using
the fall of the dollar and the continuance of the negligently lax monetary
policy which has contributed to this long-sought decline to force his errant
remedies on other nations.</font>
<p class="MsoBodyText"><font face="Verdana">Before anyone protests, keep in
mind that most European and Asian economies have far less"flexibility"
in the production of real wealth than the <ST1:COUNTRY-REGION>
<ST1:PLACE>
US</ST1:PLACE>
</ST1:COUNTRY-REGION>
, despite all its rulers' errors of policy and prescription. This makes
Greenspan's sin all the more heinous.</font>
<p class="MsoBodyText"><font face="Verdana">So hang in there, Jean-Claude. We
need you!</font>
<p class="MsoBodyText"><span class="279155513-22012004"><font face="Verdana">_________________________________</font></span>
<p class="MsoBodyText"><font face="Verdana">Sean Corrigan is a principal of </font><font face="Verdana">www.capital-insight.com</font><font face="Verdana">,
a London-based economic consultancy. He is also comanager of the Bermuda-based
</font><font face="Verdana">Edelweiss
Fund</font><font face="Verdana">. See his Mises.org </font><font face="Verdana" color="#000080">Articles
Archive</font><font face="Verdana">, or send him </font><font face="Verdana" color="blue">MAIL</font><font face="Verdana">.
See also the </font><font face="Verdana">Study
Guide on Business Cycles.</font><font face="Verdana">
</font></font>
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