I was recently asked the following set of questions: “If the value of the dollar drops, does that increase the demand for US exports? Is it possible that the dollar is intentionally being devalued by the US government in order to create jobs?”
Here is my non-answer:
Any University macro class will teach that a devalued currency bids well for domestic exports as well as domestic consumption of domestically produced goods. As the world supply of US currency increases, it becomes cheaper for countries to purchase that currency, and in turn purchase goods from firms that sell goods denominated in the dollar (pretty much every firm in the US). Also, when the US dollar loses purchasing power, more dollars are required to purchase foreign currencies used to purchase imports. For example, each USD purchases fewer and fewer Chinese Yuan. Imagine a firm that imports a component from China that costs 100K Yuan. Today, it will cost $15,410 to buy 100K Yuan. But, as the dollar devalues, the price of a Yuan increases. What if the USD devalues so much that it trades 1:1 against the Yuan? Suddenly that component costs $100,000 and the US firm looks within its own borders and finds a similar component for $17,000. So it purchases domestically. Likewise, that firm competes globally with an Italian firm, who uses similar components which it used to buy from China, after trading Lira for Yuan. However, since the USD is so cheap now, the Italian firm can trade Lira for dollars and buy the component from an American firm for cheaper than from China! Controlled inflation is a boom the US economy! A boom for jobs! And that makes sense why the Fed (not the US government) is always inflating the currency. The Federal Reserve has two congressional mandates: keep prices stable and maintain full employment.
Now, the great free market economist F.A. Hayek once said, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” So now I begin:
The problem with all of those manipulations is that they, along with all of modern economics, are based on one simple impossibility: the expectation of ceteris paribus. It is the principle that makes all those charts and graphs and mathematical models work in this field that has become blindly obsessed with calculus. Ceteris paribus is Latin for “all other things the same”. In real life, an economist, a politician, or even the head of the Federal Reserve, cannot freeze all other actors in an economy. Ceteris paribus, the founding principle of Keynesians economics, is an impossibility. An economy is simply too complex. To paraphrase the late Murray Rothbard, the one redeeming quality of Marx is that he wasn’t a Keynesian.
One of the things that cannot be controlled is the boom/bust cycle that is always generated by expansionary monetary policy. When the Federal Reserve creates new money, not every dollar is devalued immediately. In fact, at the instance new money is created there is no change in the value of money held by others. It isn’t until the new money is spent and circulated through the economies that it becomes less valuable. This creates a perverse incentive to be the first firms to receive new money, to get it while it’s still valuable. The industries that get this new money first explode in a new investment bubble. When those bubble burst, and an economy tanks, the Fed has no choice but to turn up the presses to “stimulate” the economy again. And the cycle grows bigger, faster, more volatile, more violent.
Take for example 1997. Fears of the Y2K Bug were starting to gain real traction in policy circles. The Fed, afraid that there would be a huge demand for paper cash if computer networks crashed on New Year’s morning, began to turn on the presses, and ramp up reserves at its member banks. Well, nothing became of that bug. However, the banks, sitting on dough, began to release that cash on margin for investors. All that easy credit fueled the greatest boom in US tech history. The Nasdaq bubble, and it subsequent bust was 100% fueled by the Federal Reserve. When the economy tanked, sucking billions of dollars of wealth out of middle class America’s retirement (and it is always the middle class that gets destroyed by loose monetary policy), the Fed turned on the presses again, dumping even greater sums of money into its member banks. What ensued was the greatest real estate bubble in history. All that cheap credit turned everyday Americans, who 10 years earlier were dumping every dollar they could get their hands on into dot com stocks, into house flippers, landlords, developers, and property speculators. Until that bubble crashed, causing the greatest financial meltdown in modern history. And we all know someone who is bankrupt because of it. So, what did the Fed do? They didn’t bail out the middle class; they bailed out their politically connected investment bank cronies, and then turned on the presses. While Congress was wrangling over an $800 billion dollar bailout package, the Federal Reserve was dumping nearly three TRILLION dollars into the global economies. The Fed has almost doubled the money supply in the last three years.
Where will this new money come to roost? There is a small bubble emerging in mergers and acquisitions right now. You will begin to see some very high profile mergers. The AT&T/T-Mobile merger is a good example. Investment banks are using a lot of that cash to shuffle liabilities between firms. That isn’t a bubble that touches everyday America, but it will. Remember, not all cash devalues at the same rate. My point is, though on paper expansionary monetary policy looks like a good way to stimulate exports, it always results in economic chaos at home. It is modern day mercantilism.
There are far too many wild cards out there right now for the textbook scenario to play out the way the central planners hope, any one of which will cause real pain at home. China has a hell of a lot of our cash. If they dump it, OPEC will follow. Gas will sky rocket at home. Manufacturing will collapse. Inflation will destroy personal savings overnight. Defaults will affect real estate, automotive, education, and industrial sectors. Food prices will skyrocket since our ability to import will be crippled. When people go hungry, blood flows…
But by all means, we should be focusing on a birth certificate.
——- Additional Resources ——-
VIDEO: Fear the Boom and Bust – Hayek vs. Keynes Part I
VIDEO: Fight of the Century – Hayek vs. Keynes Part II