Currency Wars: The Making of the Next Global Crisis by James Rickards Page B
Authors: James Rickards
Tags: Business & Economics
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(C), investment (I), government spending (G) and net exports, consisting of exports (X) minus imports (M). This overall growth definition is expressed in the following equation:
GDP = C + I + G + (X − M)
An economy that is in distress will find that consumption (C) is either stagnant or in decline because of unemployment, an excessive debt burden or both. Investment (I) in business plant and equipment and housing is measured independently of consumption but is nevertheless tied closely to it. A business will not invest in expanded capacity unless it expects consumers to buy the output either immediately or in the near future. Thus, when consumption lags, business investment tends to lag also. Government spending (G) can be expanded independently when consumption and investment are weak. Indeed, this is exactly what Keynesian-style economics recommends in order to keep an economy growing even when individuals and businesses move to the sidelines. The problem is that governments rely on taxes or borrowing to increase spending in a recession and voters are often unwilling to support either at a time when the burden of taxation is already high and citizens are tightening their own belts. In democracies, there are serious political constraints on the ability of governments to increase government spending in times of economic hardship even if some economists recommend exactly that.
In an economy where individuals and businesses will not expand and where government spending is constrained, the only remaining way to grow the economy is to increase net exports (X − M) and the fastest, easiest way to do that is to cheapen one’s currency. An example makes the point. Assume a German car is priced in euros at €30,000. Further assume that €1 = $1.40. This means that the dollar price of the German car is $42,000 (i.e., €30,000 × $1.40/€1 = $42,000). Next assume the euro declines to $1.10. Now the same €30,000 car when priced in dollars will cost only $33,000 (i.e., €30,000 × $1.10/€1 = $33,000). This drop in the dollar price from $42,000 to $33,000 means that the car will be much more attractive to U.S. buyers and will sell correspondingly more units. The revenue to the German manufacturer of €30,000 per car is the same in both cases. Through the devaluation of the euro, the German auto company can sell more cars in the United States with no drop in the euro price per car. This will increase the German GDP and create jobs in Germany to keep up with the demand for new cars in the United States.
Imagine this dynamic applied not just to Germany but also to France, Italy, Belgium and the other countries using the euro. Imagine the impact not just on automobiles but also French wine, Italian fashion and Belgian chocolates. Think of the impact not just on tangible goods but also intangibles such as computer software and consulting services. Finally, consider that this impact is not limited solely to goods shipped abroad but also affects tourism and travel. A decline in the dollar value of a euro from $1.40 to $1.10 can lower the price of a €100 dinner in Paris from $140 to $110 and make it more affordable for U.S. visitors. Take the impact of a decline in the dollar value of the euro of this magnitude and apply it to all tangible and intangible traded goods and services as well as tourism spread over the entire continent of Europe, and one begins to see the extent to which devaluation can be a powerful engine of growth, job creation and profitability. The lure of currency devaluation in a difficult economic environment can seem irresistible.
However, the problems and unintended consequences of these actions appear almost immediately. To begin with, very few goods are made from start to finish in a single country. In today’s globalized world a particular product may involve U.S. technology, Italian design, Australian raw materials, Chinese assembly, Taiwanese components and Swiss-based global distribution before
GDP = C + I + G + (X − M)
An economy that is in distress will find that consumption (C) is either stagnant or in decline because of unemployment, an excessive debt burden or both. Investment (I) in business plant and equipment and housing is measured independently of consumption but is nevertheless tied closely to it. A business will not invest in expanded capacity unless it expects consumers to buy the output either immediately or in the near future. Thus, when consumption lags, business investment tends to lag also. Government spending (G) can be expanded independently when consumption and investment are weak. Indeed, this is exactly what Keynesian-style economics recommends in order to keep an economy growing even when individuals and businesses move to the sidelines. The problem is that governments rely on taxes or borrowing to increase spending in a recession and voters are often unwilling to support either at a time when the burden of taxation is already high and citizens are tightening their own belts. In democracies, there are serious political constraints on the ability of governments to increase government spending in times of economic hardship even if some economists recommend exactly that.
In an economy where individuals and businesses will not expand and where government spending is constrained, the only remaining way to grow the economy is to increase net exports (X − M) and the fastest, easiest way to do that is to cheapen one’s currency. An example makes the point. Assume a German car is priced in euros at €30,000. Further assume that €1 = $1.40. This means that the dollar price of the German car is $42,000 (i.e., €30,000 × $1.40/€1 = $42,000). Next assume the euro declines to $1.10. Now the same €30,000 car when priced in dollars will cost only $33,000 (i.e., €30,000 × $1.10/€1 = $33,000). This drop in the dollar price from $42,000 to $33,000 means that the car will be much more attractive to U.S. buyers and will sell correspondingly more units. The revenue to the German manufacturer of €30,000 per car is the same in both cases. Through the devaluation of the euro, the German auto company can sell more cars in the United States with no drop in the euro price per car. This will increase the German GDP and create jobs in Germany to keep up with the demand for new cars in the United States.
Imagine this dynamic applied not just to Germany but also to France, Italy, Belgium and the other countries using the euro. Imagine the impact not just on automobiles but also French wine, Italian fashion and Belgian chocolates. Think of the impact not just on tangible goods but also intangibles such as computer software and consulting services. Finally, consider that this impact is not limited solely to goods shipped abroad but also affects tourism and travel. A decline in the dollar value of a euro from $1.40 to $1.10 can lower the price of a €100 dinner in Paris from $140 to $110 and make it more affordable for U.S. visitors. Take the impact of a decline in the dollar value of the euro of this magnitude and apply it to all tangible and intangible traded goods and services as well as tourism spread over the entire continent of Europe, and one begins to see the extent to which devaluation can be a powerful engine of growth, job creation and profitability. The lure of currency devaluation in a difficult economic environment can seem irresistible.
However, the problems and unintended consequences of these actions appear almost immediately. To begin with, very few goods are made from start to finish in a single country. In today’s globalized world a particular product may involve U.S. technology, Italian design, Australian raw materials, Chinese assembly, Taiwanese components and Swiss-based global distribution before
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