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Teeter-Totter Relationship Between U.S.$ and Foreign Currencies

28 Jul

USDX [courtesy Google Images]

USDX
[courtesy Google Images]

The “Group of 20” (G20) includes the world’s 20 biggest industrial and emerging economies. G20 finance ministers and central bank chiefs met in China on Saturday and Sunday (July 23-24, A.D. 2016).

According to the AFP (“US Warns Against Devaluation Ahead of G20 Finance Meeting”), on the Thursday before this G20 meeting:

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US Treasury Secretary Jacob Lew said that top economies should refrain from competitive currency devaluations–a message likely directed at China.

According to Secretary Lew, “The global outlook . . . underscores our focus on the commitment made at the last G20 in Shanghai to consult closely with one another on [currency] exchange rate policy, and to refrain from competitive devaluation.”

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First, the term “competitive currency devaluations” is misleading insofar as “competitive” signals something civil like a genteel, after-dinner game of Whist in the parlor. In fact, these “competitive currency devaluations” are almost as potentially serious and lethal as nuclear war.

(More, it’s conceivable that China’s “competitive currency devaluations” just might be enough to trigger naval conflict between China and the U.S. or even Japan in the South China Sea.)

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Second, Secretary Lew reminded G20 nations of their former commitments to refrain from “competitive currency devaluations” under the pretext of protecting of the “global” economy. However, as you’ll read, Secretary Lew’s true motives are probably less “global” than nationalistic in the sense that he’s trying to protect the U.S. dollar, U.S. economy and U.S. government from deflation.

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Third, it appears that the previous G20 “commitments” are “promises” of sorts, but not treaties, and perhaps not even real “agreements”. If so, the previous “commitments” from other G20 nations to avoid “competitive monetary devaluation” (inflation) aren’t worth the paper they’re printed on.

Such commitments might be observed when the global economy is strong. But, at a time when the global economy is struggling, self-interest rules and it’s every nation for itself. Therefore, if a government believes it must devalue/inflate its currency to hold its economy together, that government will devalue regardless of previous “commitments” or U.S. warnings.

This implies that Treasury Secretary Lew’s recent admonitions to avoid currency devaluations will be ineffective. He might garner some lip service in support of his warnings, but there’s unlikely to be any real support. Therefore, so long as the global economy remains depressed, we should expect to see more currency devaluations (inflation) from G20 nations.

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Fourth, Treasury Secretary Lew’s admonitions against devaluing/inflating other currencies aren’t simply the wise counsel of the beneficent U.S. government offered freely to less prudent, foreign nations. Because of the “teeter-totter” relationship between the fiat dollar (primary world reserve currency) and the fiat currencies of other nations, when foreign nations devalue/inflate their currencies, they directly cause their own currencies to decline in value—but they also indirectly cause the U.S. dollar (sitting at the other end of the currency “teeter-totter”) to increase in value and thereby suffer deflation.

Because the U.S. dollar is the primary world reserve currency, when foreign currencies change in value, they do so primarily in relation to U.S. dollars. Therefore, when foreign currencies go down in value (devalue; inflate), the fiat dollar must deflate (go up in value).

I infer that Secretary Lew’s warnings to other countries to refrain from devaluing their own currencies are not intended to help preserve those foreign countries or even the global economy from inflation. I infer that those warnings are intended for the primary purpose of helping to protect the fiat dollar and U.S. economy from deflation.

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Most Americans might suppose that a “stronger” (more valuable; deflating) dollar would be a good thing. And, for some people, it is.

For example, producers who generate profits and for savers, they’d be right. Deflation is great for businesses producing a profit since the dollars used to measure that profit are growing in value. If your business earned $100,000 in profits while the dollar experienced 10% deflation, the value (purchasing power) of your $100,000 would grow to $110,000.

Deflation is also great for those who have savings or pension funds. I.e., if you had $100,000 in your bank or pension account and the dollar experienced 10% deflation, you’d still have the nominal “$100,000” in your account but, thanks to deflation, your savings would have $110,000 in purchasing power.

So, while inflation is bad for profitable businesses and for people who have savings, deflation is great for such people because they’re enriched by deflation.

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However, if deflation is good for the relatively few producers who generate profits and the relatively few who have significant savings, it’s terrible for the vast majority of people who can’t generate profits and have no significant savings.

For example, deflation is bad for:

1) Debtors. Deflation forces debtors to repay their existing debts with more valuable dollars. This increased cost of paying debts can push overly-indebted people, corporations and even governments closer, and perhaps into, bankruptcy.

2) Potential borrowers. Stronger, deflating dollars discourage people from borrowing more currency since they know they’ll have to repay with more valuable dollars.

3) Businesses that depend on debt like home-builders or oil-producing companies. Very few homes will be built or sold if the public is unable or unwilling to go into debt by taking a mortgage. Likewise, few new oil wells will be drilled and existing oil company debt may become unpayable if the cost of repaying existing debt rises. Deflation increases the cost of existing debt and inhibits people from borrowing more. Deflation will hurt and perhaps bankrupt many companies that build homes or drill for oil.

4) The U.S. government. The U.S. government is the world’s biggest debtor and also biggest borrower. In a period of deflation, government will have to repay its existing debts with more valuable dollars thereby increasing the true size of the National Debt and also increasing the probability that the U.S. government will be forced to admit it’s bankrupt. Likewise, as the dollar’s value rises (deflates), government will be less able to afford to borrow and use more borrowed currency to “stimulate” the economy. (As I’ve said for some time, unbridled inflation will destroy the fiat dollar but unbridled deflation will destroy the overly-indebted government.) And, finally,

5) The U.S. economy. The U.S. monetary system and economy are based on debt (promises to pay) rather than assets (payments). Insofar as deflation increases the cost of debt and inhibits potential borrowers from going deeper into debt, deflation will slow our debt-based economy and perhaps push it into a depression. Inflation “stimulates” the economy by encouraging people to borrow and spend and repay with “cheaper” dollars. Deflation “de-stimulates” the economy by discouraging people from borrowing and spending because they’ll have to repay with “more valuable” dollars.

My point is that Treasury Secretary Lew is not warning the other G20 nations against further currency devaluations because the resulting inflation will hurt those foreign economies or even the global economy. Instead, Secretary Lew’s “warnings” are actually a plea to please, please, stop devaluing/inflating your damn foreign currencies because, by doing so, you’re deflating the U.S. dollar and compounding the financial stress the U.S. is already suffering.

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If my previous conjecture is roughly correct, and if foreign countries continue to directly devalue/inflate their currencies and thereby indirectly deflate/strengthen the fiat dollar, then it may become necessary to terminate the existing teeter-totter relationship between the U.S. dollar and most other foreign currencies.

I’m not sure that such a termination is even possible, but if it is, the dollar’s value would have become largely independent from foreign currencies. The dollar would have to abandon its status as primary “world reserve currency” and, as such, the “standard” against which the values of other currencies are pegged. In this “independent” condition, the dollar’s value would be more directly set by the U.S. government rather than being indirectly set by foreign governments when they devalue their own currencies.

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The problem with this theoretical “independence” is that whenever anyone sets the value of something, that value is always expressed in relation to something else.

Today, the dollar’s value is set by the US Dollar Index (USDX). The USDX is a “teeter-totter” relationship between the dollar (on one end of the “teeter-totter”) and a basket of six foreign currencies on the other end. Because of this teeter-totter relationship, when the average value of the six foreign currencies goes down (inflates), the value of the U.S. dollar must go up (deflate).

Thus, if most or all of the six foreign currencies were devalued (inflated) at the same time, they’d cause the U.S. dollar to suffer significant deflation. Given that deflation is bad for debtors, borrowers, businesses that depend on debt, the U.S. government, and the U.S. economy, you can see why Treasury Secretary Lew admonished G20 nations to please, pretty please, stop devaluing their currencies.

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However, what if the dollar’s value were no longer set in relation to yen, euros and other foreign, fiat currencies? Then, the dollar’s value would have to be expressed in relation to something else.

What could that “something else” be?

How ‘bout ounces of gold?

So long as the U.S. dollar’s value is set in relation to foreign, fiat currencies, its “teeter-totter” relationship to those currencies will be unavoidable. So long as that “teeter-totter” relationship persists, it will be impossible for the U.S. dollar to avoid suffering deflation whenever foreign governments cause their own currencies to be devalued/inflated.

The significance of the “teeter-totter” relationship is huge. It’s far more than an economic curiosity. So long as that relationship persists, the U.S. government and Federal Reserve can’t really control the U.S. economy since foreign countries are indirectly controlling the perceived value of the U.S. dollar. While the U.S. government and Fed are practically screaming to cause 2% annual inflation, that objective can be frustrated by foreign countries that react to the global trade depression by devaluing/inflating their own currencies in relation to the U.S. dollar—and thereby cause the U.S. dollar to be deflated.

Teeter-totter. Whenever those foreign currencies go down in value (inflate), the U.S. dollar on the other end of the teeter-totter must go up (deflate).

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Again, I’m not sure it’s even possible to completely terminate the teeter-totter relationship between the U.S. dollar and foreign currencies. But if such termination were possible, the U.S. Dollar Index (a teeter-totter relationship between U.S. dollars and six foreign currencies) and the dollar’s status as world reserve currency would have to be abandoned. Once those relationships were abandoned, foreign countries could not cause U.S. dollar deflation by inflating their own currencies.

But, if those relationships were abandoned, the world (including the U.S.) would be forced to create and use some other relationship to measure the values of its currencies. Would the world be forced to value their currencies in relation to something tangible, like gold?

I think the answer must be Yes.

In fact, I begin to suspect that the teeter-totter relationship that must exist between fiat currencies and the “world reserve currency” may be the fatal flaw in the fiat monetary system. Why? Because eventually, the world’s economy will tank. When it does, most currencies will be devalued/inflated in relation to the “world reserve currency”. The world reserve currency will suffer deflation which will at least slow, and perhaps destroy, its economy. Being the nation able to issue the world reserve currency is a great advantage when the global economy is hot. But when the global economy cools, being the nation that issues the world reserve currency can be a dangerous and potentially lethal disability.

The world reserve currency is the currency of the world’s dominant “super-power”. So long as that super-power is sufficiently powerful (and wise) to arbitrarily set the values of other currencies, the global trade system can survive. But if that super-power weakens and loses its capacity to effectively fix the values for other, foreign currencies, then those foreign governments and their foreign currencies will become strong enough to indirectly control the value of the “world reserve currency”. Insofar as Japan, China, or the EU can effectively control the value of the U.S. dollar, the U.S. is vulnerable to big trouble.

The only ways out of that trouble are:

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1) Restore the U.S. former super-power status and ability to arbitrarily fix the value of foreign currencies. I doubt that this solution can be achieved without instigating and winning another World War. (In fact, I begin to vaguely wonder how many other wars have been waged for the primary (though secret) purpose of establishing the victor’s right to control the value of the vanquished nations’ currencies.) And,

2) Return to a gold standard where all currencies’ values are measured in terms of gold rather than in terms of some other fiat currency. Then, if China or Japan wants to devalue their currencies—great! Those devaluations would have virtually no impact on the value of U.S. dollars backed by a fixed weight of gold. The U.S. economy would not be subject to significant foreign influence or control.

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If this conjecture is roughly correct, it follows that some members of the U.S. government and Federal Reserve must have also recognized the intrinsic dangers of the “teeter-totter” relationship between fiat dollars and foreign currencies. If enough foreign nations conspired to act in concert to simultaneously and dramatically devalue/inflate their currencies, they might thereby cause enough deflation in the U.S. to bankrupt scores of major U.S. corporations, banks and even the U.S. government, itself.

This would be real “currency war”. If the Chinese yuan, Japanese yen and European euro were all significantly devalued/inflated at the same time, they might be able to cause so much dollar deflation that the U.S. economy and government would fall into bankruptcy and overt economic depression.

Currency war” can be deadly serious. “Currency war” is ultimately made possible by the “teeter-totter” relationship between fiat dollars and foreign, fiat currencies.

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Even if several major foreign economies don’t conspire to simultaneously devalue their currencies, they could still act “coincidentally” to simultaneously devalue/inflate their currencies and thereby cause significant deflation of the U.S. dollar.

So long as there’s a global economy (or even a new world order) there must be global trade. But, so long as global trade is depressed, individual nations will seek to stimulate their own exports by devaluing/inflating their currencies. So long as the U.S. dollar remains the standard against which the value of other currencies are measured, and the global economy is depressed, other nations will devalue/inflate, and the U.S. dollar will be pushed deeper into deflation—which could collapse the U.S. economy and even government.

In other words, the facts of: 1) global fiat currencies; and, 2) global economic depression—will force some major foreign countries to devalue/inflate their currencies. That devaluation/inflation by foreign currencies will force the U.S. dollar to deflate. Persistent dollar deflation will inevitably push the U.S. closer, or into, an economic depression.

This chain of cause-and-effect won’t be broken until either:

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1) The global trade depression ends and we see a real economic recovery wherein foreign nations are no longer forced to devalue their currencies; or

2) The U.S. dollar is revalued in terms of gold rather than in terms of foreign, fiat currencies.

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It’s hard to see how the U.S. government and Federal Reserve would want to sustain a system that exposes the fiat dollar to deflation caused by foreign governments. In fact, it’s hard to see how the U.S. government and U.S. economy can avoid economic depression or even survive so long as the value of U.S. dollars is being indirectly set by foreign countries.

Therefore, it seems likely that at least some people in the U.S. government and Federal Reserve must be looking for a way to terminate the dollar’s “teeter-totter” relationship to foreign currencies. If so, I can’t yet imagine any other way to terminate that relationship without going back to a gold standard where the dollar’s value is measured and fixed in terms of physical gold rather than left to be constantly changing based on the persistent devaluations of foreign currencies.

If I’m right, “somebody up there” (in government or the Fed) should increasingly advocate the idea and necessity of returning to a gold standard.

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But. There’s a problem with all this conjecture.

What if the rumors are true that, in order to preserve the fiat dollar, the U.S. government and Federal Reserve have secretly sold off virtually all of the 8,200 tons of gold they still claim to have?

What if the U.S. has no more gold?

Without a treasury full of gold, we can’t return to a gold standard for dollars.

Then what?

If the teeter-totter relationship between U.S dollars and foreign currencies must be abandoned, but a new gold standard is truly impossible to implement, then two options remain:

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1) The “rock”: persistent dollar deflation caused by foreign currency devaluations that ultimately precipitates a national economic depression; and,

2) The “hard-place”: WWIII to reestablish the U.S. government’s power to arbitrarily set the values of most foreign currencies.

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Buckle up.

 

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6 responses to “Teeter-Totter Relationship Between U.S.$ and Foreign Currencies

  1. moon

    July 29, 2016 at 11:28 AM

    “Buckle up”? Al, you’ve used that expression in a way I rarely think of it.

    This post reminds me of what Paul Harvey said to a seminar group in the late seventies. Those were the good old days when you got in line to get gas and hoped the supply wouldn’t run out before you got to the pump (We probably wouldn’t have survived without Rock n Roll.) Paul Harvey suggested the trade: a barrel of oil for a bushel of wheat…take it or leave it. Yep, it sounded funny then too.

    If you don’t have gold, do you think wheat might work? Well, it could, but too many folks are making too much money with this teeter-totter you’ve suggested, and war is too tempting to use to keep the juice flowing until it all crashes.

    This will get fast and fun!

     
  2. Adask

    July 29, 2016 at 11:55 AM

    Wheat could work, but not as well as gold. A bushel of wheat weighs about 60 pounds and, if I understand correctly, costs about $5 from the farmer. Thus, right now, one ounce of gold can buy about 270 bushels of wheat that weigh a total of about 8 tons. I can carry an ounce of gold in my pants pocket, but I’ll need a fairly big truck to haul 8 tons of wheat. If I’m trying to trade my 8 tons of wheat to a foreign buyer, I’ll need to pay some substantial shipping charges to haul my wheat across the Pacific Ocean to, say, China. I could move my one ounce of gold to China for less than $50.

    Plus, wheat is vulnerable to getting wet, rotting, being eaten by rats, being contaminated by toxins, while gold is almost immutable.

    There’s a lot of convenience involved in buying and selling with gold that isn’t available in buying and selling with wheat.

    Of course, you can’t eat the gold and you can eat the wheat. But, unless you’re really, really hungry, you’d better buy and sell with the gold rather than with wheat.

     
    • moon

      July 29, 2016 at 2:25 PM

      True, BUT, my attempt at a point was intended toward world trade without gold, as you suggested, rather than your own stash.

       
  3. Adask

    July 29, 2016 at 2:29 PM

    True, by my comment was only intended to be a bit of dry (very dry) humor.

     
    • moon

      July 30, 2016 at 7:01 AM

      Very dry indeed…stick it in your martini.

       
  4. moon

    July 30, 2016 at 7:34 AM

    So…allow me to attempt to get this conversation back toward something worthwhile. There’s a movie, released this weekend, called Hillary’s America. From what I’ve heard it’s very factual and more for education than entertainment. The release is very timely. Check it out if you’d like and then let me know if I should brave an hour or two in a dark room full of strangers.

     

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