The Value of Money and Joining the Currency Wars

Martin Wolf has an excellent piece in the FT about growing global currency wars and the structural problems beneath, particularly he talks about China and the great problems their economic model will have in accommodating a higher valued yuan. He points as an example to Japan in the late 80s, when they were forced by the US to raise the yen:

It is not hard to see China’s point of view: it is desperate to avoid what it views as the dire fate of Japan after the Plaza accord. With export competitiveness damaged by its soaring currency and pressured by the US to reduce its current account surplus, Japan chose not the needed structural reforms, but a huge monetary expansion, instead. The consequent bubble helped deliver the “lost decade” of the 1990s. Once a world-beater, Japan fell into the doldrums. For China, self-evidently, any such outcome would be a catastrophe.

It's important to point out here that in the 80s money revaluation was used to try and change what were structural problems. The problem got worse for Japan when the money revaluation led to further internal monetary engineering -- the great Japanese financial bubble and its subsequent popping. Wolf concludes,

What is needed is a route to these needed global adjustments. That will demand not just a will to co-operate that now seems sorely lacking, but greater imagination about both domestic and international reforms. I would like to be optimistic. But I am not: a world of beggar-my-neighbour policy is most unlikely to end well.

In his piece, Wolf brings up one of the great quotes of money politics of the last half-century, Nixon's Treasury Secretary John Connally's quip to the Europeans that the dollar "is our currency and their problem." Today, I think it would be better said, the dollar is our currency and our and the world's problem. Just as the Japanese in the 80s tried to avoid necessary reform of structural problems with monetary policy, so did we. Our financial bubble grew larger and lasted longer. Now that it popped, we once again are doing everything we can to avoid necessary restructuring of the real economy and instead using monetary shenanigans. In doing this, we are creating increasingly dangerous volatility in global currency values and removing the value of money increasingly further from the physical economy, thus in turn creating further global structural distortions.

Historically, one would tend to think this monetary problem would show-up with inflation. But, it would seem we are very much entrenched in a deflationary era. While Mr. Bernanke understands this, he doesn't know what to do about it, and instead of solving the problem, which needs to be solved in bringing some balance to the physical economy, he continues to try and bail out a broken global financial system, both distorting the physical economy and in turn further devaluing money in general. Leaving a lot of bad money on the books begins to undermine good money. The easiest way to understand this if the banks are holding paper worth half of what it says, yet the Fed pumps money into the system, allowing the banks to hold the bad money, it begins to put questions on the value of the good debt, and as this debt in many ways values, as much as anything else, the currency in which it is owed, the value of the currency itself increasingly comes into question.

With inflation, the breakdown of money and the economy shows up in ever spiraling prices. However, in this era of at best economic stagnation, deflation, and currency volatility, it shows up in less economic activity, hitting particularly hard the bottom, who don't have inflationary money, but no money, while the top is flooded with money of questionable value, and decreasing economic activity putting into question the value of that money.

Thus what accompanies the currency war, is a growing war amongst finance as to what debt is good or bad, with people continuing to position themselves to keep hold of the good money, while forcing the bad money onto others. This also begins to come straight into politics as policy recommendations try and make sure "good" debt stays good for those who own it and the losses of "bad" debt are forced on everyone else. Right now, our financial aristocracy is the only one in this fight, it's time for us to join and make them take losses, look now folks, the currency wars are raging in your backyard.