The struggle for competitive advantage has begun!
Quantitative easing or printing money by Central Banks buying up Government Bonds is the means for driving down long term interest rates within the country, as well as obviously increasing the amount of cash floating in the economy. Ultimately it must make the currency less palatable to hold and exchange rates will move down.
We have had salvo’s from the UK, Switzerland and USA in quick succession, Canada have announced that they will be following suite. The markets are responding and we are seeing the first
reactions of the markets, with exchange rates very much in line with expectations.
Some time ago, when playing with my models I tried to find a set of exchange rates that would bring World Trade into a closer semblance of equilibrium, while it is difficult to establish the elasticity of each countries international trade to price change, it has become even more difficult to get to grips with the marginal propensity, of the various populations, to consume. When the future becomes murky, and the human squirrel factor (see my commentary … “The UK where to now) kicks in, all old trends go out the window, so at best these rates are a stab in the dark.
Looking at the major trading blocs: USA, Japan, China and the Euro Zone.
Possible equilibrium exchange rates against $1 are as follows;
Euro = .74
Yen = 87
Yuang = 5.2
These rates are what I believe are the maximum sustainable rates by the three main trading blocs.
Whether we can ask China to take the pain of a 25% re-valuation is open to debate, the Chinese Economy, in spite of its scale, is still a developing economy. While it has experienced a phenomenal growth rate, that has been from a low base with very high unemployment, making wage rates low.
Can you honestly ask someone in a worse position than yourself to subsidise you?
I believe the answer is no, regardless of how much it might help the rest of the world.
Japan and the Euro Zone are, however, able to sustain this change as their per capita GDP and unemployment levels are on the same plain as the USA.
Is there any likelihood of an agreement for concerted action by the G20 at their summit in April?
No!
Because there are fundamental disagreements on the right course of action, and every country has a primary responsibility to its own people.
What is likely to happen?
Let us look at the China position, as that has to be the clue to the future.
China are taking their first steps in “freeing” their currency and will (experimentally) be allowing trade settlements in Yuang out of Hong Kong.
They also have a serious problem with their reserves, these amount to some $2.4 trillion, (officially 1.95 but they also have some hidden reserves), their problem is that 70% of these are $ denominated. This puts them at risk to a collapse of the $. We can expect over the next year they will try and bring the $ component of their reserves down to 50%. The probability is that they will use a two pronged strategy converting mainly their hidden reserves into commodities and Euro. Once they achieve a 50% their risk is virtually eliminated as a dollar collapse will be compensated by a corresponding increase in other reserves.
China have already said that other countries cannot ask them to re-value the Yuang. They have also said that they have no intention of announcing further fiscal stimulus packages, and will only react as their economy demands.
Perhaps a quote from the Asia Times;
“There is mounting evidence that China’s central bank is undertaking the process of divesting itself of longer-dated US Treasuries in favor of shorter-dated ones.
There is also mounting evidence that China’s increasingly energetic new campaign of capitalizing on the global crisis by making resource buys across the globe may be (1) helping its central bank to decrease exposure to the dollar, while (2) simultaneously positioning China to make much greater profit on its investment of its reserves into hard assets whose prices are now greatly beaten down, while (3) also affording it greatly increased control of strategic resources and the geopolitical clout that goes with it. This is turning out to be a win-win-win situation for China as it capitalizes upon the important opportunities afforded it by the present global crisis.”
The Euro Zone. In spite of rumblings in various countries about the need to look after their own populations first, are standing firm in their position that they will not apply any quantitative easing.
Why?
Possibly two reasons, they are the major beneficiary of the switch out of Dollars as a reserve currency and of course the 1923 episode in Germany has not disappeared from their conscience. Obviously if the actions of the USA and UK distort the market beyond their ability to endure they will change their stance.
Japan will in probability also be diversifying their foreign reserve holdings as, indeed, should every country, obviously this has to be done subtly as any major moves by the large holders of dollars will precipitate the collapse of the dollar.
The UK and USA buying up of Government Bonds by their Central Banks provides all these countries with an ideal opportunity, of converting their long term treasury bills into currency and thereby into commodities and alternative assets.
The G20 summit will therefore fail, just as the summit in 1934 failed to reach agreement and countries rushed off to devalue their currencies in a bid to create competitive advantage.
The only agreement that will provide stability to the markets is one which re-aligns exchange rates,to bring about an equilibrium in international trade.
We can talk until the cows come home about regulation and the like, but that will never bring about stability.
Printing money will not get general approval from China or the Euro Zone, nor should it.
Quantitative easing is another attempt at stimulating the UK and USA economies without dealing with the structural problems that have grown and developed in those economies. Both the UK and the USA need to address their own problems, without calling on the world to bail them out.
There is no actual evidence that the Japanese experiment, of quantitative easing, in 2001 worked. Public Works programs played at least as big a part in bringing it out of deflation.
I foresee a future, where the role of the USA economy is substantially reduced and their freedom to print money curtailed by the lack of appetite for their paper.
I foresee in the shorter term that the Euro Zone will be active in the currency markets to prevent Sterling dropping much below parity as well as keeping itself pegged fairly close to the current rate against the Dollar, strangely enough it is within their power to do so without resorting to quantitative easing although that might hamper their ability to support the weaker members of the union.
Look at my earlier blog on the World Monetary System for an alternative to the current course.