It seems to me that the whole argument for currency debasement to make our exports more competitive is based on the assumption that it will reduce the trade deficit. I feel like that will not necessarily happen because inflation not only reduces the costs of our exports to foreign consumers, it also drives down interest rates, which encourages greater use of credit by the masses and further induces them to consume more than they produce. The abundance of cheap credit then drives the demand up for all goods, and since much of our manufacturing base has been shipped over seas because of taxes, regulations and aggressive trade unions, imports will have to fulfill many of the demands of the American consumer, thus counteracting at least some if not all of the affects that inflation might have on the trade deficit. Am I correct in this notion?
Your reasoning seems correct.
If you want to temporarily subsidize exports by inflation, then the central bank must perform very particular types of purchases on the open market. Purchases that it hopes will manipulate the exchange rate between the US dollar, and say the Chinese Yuan. Assume a floating exchange ratio, if for example the Fed bought huge amounts of the Yuan with new dollars, that may strengthen the Yuan relative to the dollar, giving the Chinese importers temporarily more purchasing power.
This doesn’t even work very well for central banks who did and do stuff like this because speculators usually will step in immediately and make the correction. It becomes a cat and mouse game, which of course always ends by the speculators getting blamed for manipulating the currency. I’m not joking.
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Inflation drives down interest rates? Huh?
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Imports will have to fulfill many of the demands of the consumer. That’s true, but if the currency has been debased they cannot afford to import stuff like they used to. So the result will be empty shelves at home and in the stores, not more imports.
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The maestro, Peter Schiff, explains the idiocy behind debasing the currency hoping to increase exports in his recent videos. The gist is very simple. Say you have a store and people aren’t buying. So you start selling at half price. Sure people will buy more, but you haven’t made any more money. Debasing the currency is exactly the same as selling at half price. You are charging the Chinese fellow less yuan for your goods. And so you can buy less of his product in exchange for what you gave him. In other words, his stuff is more expensive now.
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The only advantage of debasing the currency for an American produce ris that it raises the price of Chinese stuff in America, so that he may have a chance of selling his expensive stuff to Americans. SO it has the exact same effect as a tarrif, In other words, a small handful [the producers] benefit at the expense of the whole country [the consumers]. Which is of course bad for the economy as a whole, because it becomes less productive.
Sorry, I should have distinguished between price inflation and expansion of the money supply here. When the Fed purchases securities it does so from banks; this money acts as extra reserves that the bank can then use to loan out to people and businesses. The more money that a bank has available to loan out the lower the interest rate becomes. So that is what I meant when I said inflation drives down interest rates.
It’s funny that you quoted Peter Schiff here, because the article that you are referring to is the article that inspired this post. So I am familiar with the arguments you have presented, I was only trying to further discredit the argument “currency debasement makes our exports more competitive” by making the argument that I presented above.
Based on this, and what I said in my earlier post (especially about America’s manufacturing sector), it would appear that expansion of the money supply would initially cause an increase in the trade deficit, due to an expansion in credit, but when price inflation catches up with monetary inflation, the consumer will not be able to purchase as much as he use to with his funds. Furthermore, our exports will only be more competitive on the global market if other countries have not debased their currencies to the extent that we have, or as DD5 said the Fed performs very specific open market operations to devalue it’s currency relative to another floating currency, which as he points out, will only be temporary. As Peter Schiff points out in his article “race to the bottom,” other counties are trying to debase their currencies to keep their exports competitive, and if we do win the “race to the bottom,” as Peter Schiff suggests we will, it is akin to selling everything at 50% off, we will sell more, but we wont be any better off because of it.
Here is the article that we were referencing: http://www.europac.net/commentaries/race_bottom
Well, first, credit does not “increase the demand for all goods.” The demand for goods, in general, is infinite. Artificially lowered interest rates and credit expansion merely misdirect the allocation of scarce resources towards economic employments that may or may not be sustainable/warranted in the long run. In the long-run, it may increase total consumption of final goods and services, but only at the expense of producer goods (investment), which are also demanded (derived demand), and which constitute a much larger proportion of total production (relative to the production of final consumer goods and services).
It is true that currency manipulation and changes in interest rates go hand-in-hand; that is, the devaluation of currency yields lower (market) interest rates, but it has the opposite effect of what you’re describing. The artificially reduced interest rates cause “capital flight,” or, in other words, capital will “flow” from nations with lower interest rates towards nations with higher interest rates, all other things equal (capital chases higher returns). This, in turn, will devalue the currency by an even greater extent (self-perpetuating). This is not how the system works under a gold standard.
In other words, there is an inverse relationship between our current account (trade surplus or deficit) and our capital account. Our current condition is characterized by an artificially over-valued dollar, which draws capital and foreign investment towards the U.S. from other nations.