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Free Trade Will Be Only Victim of Currency War

Irwin M. Stelzer

Growth. The summum bonum of economic policy. Tough to arrange at home: stimulus packages don’t work very well, and monetary policy produces lots of fiat money but not many jobs. The solution: export-led growth—the other guy will buy so much of your goods and services that your economy will grow.

There are two ways to make this happen. Lower the international value of your currency so that your output is cheaper overseas, or increase productivity at home by lowering labour and other costs and therefore the prices you need to charge foreigners.

The first is painless, or so it seems initially. The second requires a politically difficult assault on benefits and union-created labour market rigidities.

So it should come as no surprise that France’s president François Hollande, whose largely unreformed labour market has kept unit labour costs so high that French goods—luxury items, food, aircraft—are struggling in world markets, should want the eurozone to set a “realistic”—lower—exchange rate for the euro. Germany’s economy minister, Philipp Rösler, whose country went through the pain of labour market reform and wage restraint and is having no trouble exporting goods, responds with a definite nein: “The objective must be to improve competitiveness and not to weaken the currency.”

Mario Draghi, head of the European Central Bank (ECB), straddled the Franco-German divide by reminding Hollande that the ECB is independent, but at the same time hinting that if the strong euro reduced the threat of inflation he might ease further, a hint that brought the euro down by about one cent against the dollar.

Hollande wants to enter what the media are calling the currency wars. Economists prefer the term “competitive devaluations” because one country’s devaluation leads to competitive responses from other nations.

It is not clear, of course, that the road to riches runs through a devaluation of the national currency. Such a move makes imports more expensive, driving up inflation. It also drives up the cost of raw materials bought by domestic manufacturers and eases pressure on them to keep their costs down, since they have less to fear from the now more expensive foreign competitors.

But politicians who play the devaluation game hope that consumers will not notice—witness then-prime minister Harold Wilson’s infamous statement that the 1967 devaluation of the pound only meant that British goods would be cheaper overseas but: “It does not mean that the pound here in Britain, in your pocket or purse or in your bank, has been devalued.”

Such dissembling is the language of choice of most politicians when it comes to the value of their currencies. “A strong dollar is one of our greatest weapons against inflation,” intoned Ronald Reagan—and one year later devalued the currency 50%. Presidents ever since have stuck to the line that a strong dollar is in America’s interests, while at the same time proposing export-led growth.

Until now, China has been the world’s devaluer par excellence, keeping the yuan low so that its export-led economy could continue to provide jobs for the millions of Chinese moving off the farms and into the cities. Now, Japan’s new prime minister Shinzo Abe has joined the war, pressing his central bank to print money and rescue Japan from “the strengthening yen.” From Abe’s point of view, so far so good: the yen has fallen about 15% against other currencies, making Japanese cars and other products cheaper overseas; the Nikkei share price index is up about 35%; and American importers are again ordering Japanese products. The Organisation for Economic Co-operation and Development estimates that this currency shock will raise Japan’s GDP (not adjusted for inflation) by 2%-3% if devaluation stops at this level.

Brazil, experienced in currency wars, coupled its own devaluation with a plea for the World Trade Organisation to let it raise tariffs on other devaluers. That idea has been bruited about in America, where leading Democrats want to put tariffs on made-in-China goods to offset the disadvantage American firms face from China’s currency manipulation.

Meanwhile, Britain is about to get a new governor of the Bank of England who is unlikely to be a reluctant recruit to the currency war, although, like all central bankers, he will deny participation. Last week Mark Carney, governor designate, told the Commons Treasury committee he will use all tools at hand to revive the British economy, including its export sector. If use of those tools causes sterling to drop, so be it.

It should be obvious that the currency war is a trade war by other means. The use of traditional weapons—tariffs to keep out imports and thereby increase demand for homemade products and create jobs—was outlawed by mutual consent of the warring parties when they agreed to abide by the rules of the World Trade Organisation. So a new weapon of trade destruction has been rolled out—the printing press. Run the presses, flood the markets with your currency, and later, if not sooner, your currency will depreciate, giving you an edge in world markets. Until trading partners respond.

America and Britain, among others, have already deployed that weapon, and the new head of Japan’s central bank is likely to be chosen from the warrior class. Germany, not overjoyed with Draghi’s hint that he might take up arms, continues to insist that the ECB remain a noncombatant. Angela Merkel has made it clear that she and her voters remember what happened to Germany the last time it ran the money presses overtime, and agrees with Vladimir Ilyich Lenin that “the best way to destroy the capitalist system is to debauch the currency,” a view with which John Maynard Keynes agreed: “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society.”

The difference being that Lenin would be cheering the currency wars, Keynes bemoaning them.

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