The Big Picture
“War is robbery, trade is a swindle.” – Ben Franklin
A trade war, and its relative the currency war, are actually quite simple strategies and their execution is straightforward. The trade war involves assessing another country for their imports, via a duty or a tariff. In turn, the country being imposed the tariff then assesses its own in retaliation. A currency war involves the process of devaluing the domestic currency against the foreign currency to make domestic exports less expensive therefore reducing the competitiveness of the foreign industry. Both are essentially an attempt to take advantage of another country. Or a “beggar thy neighbor” economic policy.
The history of trade and currency wars is long and troublesome. The efficacy of these approaches is mixed at best, with most pundits believing that trade and currency wars are not successful in achieving the desired goal. The tit for tat exchanges simply go on until a new negotiated deal may be reached. Or, a more serious war begins, which is obviously in everyone’s interests to avoid.
Have a Plan and a Process!
From the Trenches
“Global trade has its advantages. For starters, it allows those of us who live through winter to eat fresh produce year-round.” – David Suzuki
The primary issue we come across during discussions on trade is the fairness of trade. The dispute comes down to Free trade versus Fair trade.
Free trade is the removal of all boundaries and restrictions from all parties involved. However there are issues with free trade. Free trade may create incentives to produce in unethical and even inhumane ways. For example, the cheapest cost of labor is sought, and the conditions of labor may be very poor.
Fair trade involves not only leveling the playing field, but setting some minimum standards for production. Such as a minimum wage, favorable working conditions, and standards for government involvement. Fair trade also involves increased costs that lead to increased prices.
There are pros and cons to both!
In most cases we find that trade is neither free nor fair, but somewhere in between. While there exists some imbalances to the trade scenario, generally a trade agreement will hold up for some period of time until there are changes to the overall economic landscape that make the current trade deal no longer tenable. For example, globalization picked up meaningfully in the 1990’s after the end of the Cold War. It became increasingly economical that countries far apart could do business efficiently with mutual benefits. With developments in technology, transportation, and other innovations, the scale of global trade has expanded. However, there are drawbacks to globalization as well. The effects of globalization may be one reason we have seen a drop in manufacturing jobs in the U.S. Other countries have become more competitive in certain areas of production versus the U.S. One of the most infamous examples took place near my hometown when GM moved production from Flint, MI, to Mexico. Its impact on the city of Flint was devastating, and the city has never fully recovered.
Everything in economics, and the financial markets for that matter, is a balance. And there is no perfect solution.
Every so often in economic history we enter a period where more nationalistic and protectionist ideals arise. It is no coincidence that the arrival of these beliefs come after a significant economic shock, such as the financial crisis in 2008. While there is little debate that international trade and cooperation does more good for global society than bad; there are times when the scope of the trade environment needs to be addressed and possibly reassessed. This is where we find world trade today. Of course new deals are not reached easily, as those countries receiving the advantage have little incentive to trade it away.
Bottom Line: Trade issues can lead to very perilous relations between nations. It is critically important that negotiations may lead to a mutually beneficial agreement. As the alternative benefits nobody.
“The first panacea for a misguided nation is inflation of currency; the second is war. Both bring temporary prosperity; both bring permanent ruin. Both are the refuge of political and economic opportunists.” – Ernest Hemingway
Not the brightest of outlooks on the effects of weakening economic conditions and the desperation of where they can lead. The good news is in my opinion we are not near the precipice as of yet.
Currency wars, or what economist’s call competitive currency devaluation.
Why do countries engage in currency devaluation? Contrary to belief, the U.S. engages in this exercise as well. The Federal Reserve (Fed) aims for a specific inflation target of say, 3% annually. That is the same as stating the Fed wants the dollar to depreciate, or devalue, by 3% every year. There are a few reasons for devaluing a currency:
- Exports. If we decrease the value of the currency it makes our exports more attractive, or affordable, to foreign markets. However, the U.S. is not an exporting nation. As of 2017, exports were only 12% of U.S. GDP (WorldBank).
- Lowering trade deficits. The U.S. has trade deficits with most of its major trading partners. This stems from the make-up of the U.S. economy (the U.S. is a consumption and service economy). There is significant debate on this subject and many economic theories regarding the issue with trade deficits. Does the fact that the U.S. is not an exporting nation make the U.S. economy less valuable? How do we define the wealth of an economy? Some believe the amount of treasure in the coffers defines a country’s wealth. What about the economic opportunity present? There is more to this subject.
- Reducing sovereign debt. This is an interesting and somewhat perplexing concept. Imagine you are the government and you must pay interest on debt securities owed outstanding. If you lower the value of the currency in which you must pay interest, then the cost of the debt can be reduced and even eliminated. As the government you do have tools to make this happen. Have you wondered why the Fed targets a certain level of inflation? This is one of their goals.
Reason 1 is fairly straightforward. Reasons 2 and 3 are a bit more complex and require some additional discussion and debate. For those interested in economic systems and theories, you know where to find me. For those not so interested; the point is under the current monetary system you should no longer look at your dollars as a store of value (see my post Money from July 2017). Instead, view dollars as a tool for exchanging goods and services. Savers should not be holding on to dollars for too long. Unfortunately that is a losing proposition.
Bottom Line: Currency devaluation is nothing new and is a characteristic of modern monetary systems. When used as a tool to take advantage of another nation, it can lead to a currency war.
*Posts are written covering three primary topics: Macro, or the big picture; Investment Planning considerations; And the Markets – What is going on there?
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