THE Currency World Cup has just begun, and it will be the mother of all world cups.
The stakes are high: for the winner, world domination; for the losers, economic wilderness. It is the year of the snake — I know who I’m backing to come out on top.
If you want to make sure that currency wars become entrenched in the economic policy formulation and strategy of sovereigns, then legislate against it.
The Group of 20 finance ministers are gathering in Moscow (of all places) to address currency wars. The Group of Seven countries (the richer guys) are being less direct (more polite) to one another because you just can’t be too outright with the big boys. The Bank of Japan has made its intention clear, regardless of the policy tools it employs — it wants to see a weaker yen. The European Central Bank has made clear it would like to see a weaker euro. Ignore the polite rhetoric — the game is on!
Why do people bother? The answer is simple. Countries owe each other money — lots of it right now. The most straightforward way out of debt is to generate more income. In this context, there are essentially two sources of income: internal, in the form of taxes collected within the country, and external, in revenue generated from exports. Internal revenue (taxes) is taken from the very people you’re trying to help; export revenue is from others.
The simplest way to increase the sales of the goods you produce is to reduce their "world price" by accepting payment in a currency that you have devalued. So, what’s the problem? Well, it won’t work if everyone wants to do it.
If South Africa were simply to decree that the rand/dollar exchange be fixed at 10:1 instead of 8,5:1, say, then we would get R1,650 for an ounce of gold instead of R1,320/oz. That would be great. We would have more rands to pay our mineworkers, who could then build houses, buy fridges and spend money to get the economy growing faster. So why don’t we do it? Because we’ll get sorted out or asked to leave the game.
Some American tourist will stop at the Rosebank drive-through McDonald’s and order a Big Mac. Having just changed her dollars into rand at the airport (ignoring the absurd margin she paid to do so) she’ll figure out that, in dollar terms, this hamburger, priced like any other on its basic economic worth, when converted back into dollars is much cheaper in South Africa than in the US. She’ll be on her cellphone in a jiffy to start importing hamburgers from South Africa and selling them in the US at a profit. Of course, competition won’t allow her to do that for very long before either the exchange rates or the prices come into line.
But the exchange rate is fixed (by us). So the US will ban the import of Big Macs from South Africa or impose some sort of tariff on them — in essence pitting law against law where the market mechanism fails. So if you don’t play by the (market) rules — as the US has accused China of doing — then your competitors will change the rules. In the end the big guy will win. That’s why the market mechanism is better. The world works out the fair exchange rate.
There are more eloquent descriptions of this, such as the purchasing power parity theorem, but they all conclude that the "real" exchange rate will prevail.
Of course a country can manipulate the "real" exchange rate indirectly by changing the local variables that affect it. But every intervention has a consequence. If you increase interest rates, you make your currency more attractive for the yield seekers and although imports become cheaper, exports become less competitive. Although saving becomes more worthwhile, loans are more expensive to service.
With trillions upon trillions of sovereign debt in play, the temptation to address it through exchange-rate influence is just too tempting for it not to happen. No amount of legislation will stop it.
But it is a dangerous game. Few country balance sheets are big enough to withstand the challenge implicit in a policy to defend a particular rate. Traders around the world simply start licking their chops when a relatively small sovereign proclaims a view on its exchange rate — effectively providing the world with a base figure against which to trade. Once the biggest currency trading desks combine on a view and then gear that up with derivatives, few can withstand the onslaught. The big boys can fight each other, but there’s an old African saying: "When two elephants fight, the only result is the grass gets flat."
If the world does indeed resort to currency wars to settle its differences, then we’ll be taking yet another step away from the real economy, away from the people and from the streets where the price of food and money is really determined. That will inevitably bring more people out into those same streets — and they won’t be coming out to play currency wars, but to fight.
The exchange rate is often likened to a company share price for a country. For a company, the rule is clear: get on with doing the business right and the share price will look after itself. The same is true for countries.
• Barnes has spent 30 years in finance and markets.