It seems the ‘race to the bottom’ is picking up speed; the ‘race to the bottom’ in value of fiat currencies, that is. Conventional wisdom calls for a reduction of the (relative) value of a currency, in order to ‘support export industry’. The new government of Japan, headed by Mr. Shinzo Abe, was elected on that very ‘platform’; the intention to deliberately devalue the Japanese Yen, supposedly to ‘support’ Japanese export industries.
Indeed, this theme is very common; all countries on fiat currency… that is, all countries… are using devaluation to ‘support their export industries’, and their economies… indeed, conventional wisdom says that Greece is in trouble because it has no currency it can devalue, as it uses the Euro… and power to devaluate the Euro is not in the hands of the Greek government, but in the hands of the EU… and Germany.
It is obvious that devaluation eventually fails, as any currency being devaluated against… like the Yen vs. the USD… will lead to a counter devaluation; the USD vs. the Yen… and so if the race to the bottom continues, it must eventually lead to zero currency value… of all fiat currency. If you are on the road to Hades, and you keep walking, guess where you end up.
Nevertheless, this insanity continues, in the belief that devaluation gives an edge… if only temporary… to the country devaluating. Politicians never consider the future, only the next election… and a temporary devaluation is a typical ‘kick the can’ into the future action so loved by politicians.
The real question is this; does devaluation actually do what it promises to do, that is ‘support the economy’ by ‘supporting export industries’? This deserves a closer look… and a look at the causes, not the symptoms of loss of export competitiveness and economic decline… and the true consequences of devaluation.
Let’s do some simple numbers; simple like 2 + 2 = 4… and see where the truth is. Is truth found in ‘conventional wisdom’, or in the position taken by New Austrian economists? The New Austrians’ position is simple; currency devaluation is like soldiers heading into battle, but first throwing their bullets and ammunition away, because its ‘too heavy’…!
In the modern world, all economies are intertwined; a car manufactured in the US for example, is really mostly assembled from components manufactured off shore; components like the engine, gearbox, accessories, etc… Not more than 20% to 30% of the final value of a car ‘made in USA’ is created locally, that is around 70 % to 80% of the value is imported.
Some industries have more local value added; but even something as apparently local as farming has much value added from offshore sources; diesel fuel, chemical fertilizers, capital equipment like tractors and combines, etc.
For the sake of keeping the numbers easy, let’s assume that 50% of all value is local, and the balance is imports… and get on with it. Suppose that we consider 100 Monetary Units (MU) of an export product; these MU’s could be thousands of dollars, millions of Euros… whatever, the results are the same.
If 50% of 100 MU export is local value, then 50 MU worth must be imported. So, the sale of 100 MU of goods results in 50 MU of imports, and 50 MU of local salaries and wages. Remember, all costs are salaries and wages; the raw materials, whether ore for mining, tress for lumber, grains or whatever are freely given… all cost is in extraction, production, transportation… and parasitism like taxes, regulatory expenses, overhead, bureaucracy etc.
So, assume the export industry is becoming less competitive… for whatever reason; less stuff gets sold, less salaries are paid out… the economy is shrinking. What to do? Well, the first idea is to simply lower the selling price; this is the typical knee jerk reaction to falling sales. Discount it, put it on sale, give a special… this should restore sales and competitiveness, no?
Suppose we discount by 10%; this should give sales… or ‘competitiveness’ a kick. The problem is, if we discount our exports by 10%, even if sales return to previous levels, we will sell the same quantity of stuff as before, but will only get paid 90 MU… and our costs to buy the 50% imports stays the same, at 50 MU; we end up with local value added of only 40MU… a 20% discount. Ouch.
Other things being equal, local wages and salaries must decline by 10 MU… that is, by 20%. This is very painful; labor unions, employees, worse yet voters will be outraged… why, they may even vote the rascals out… can’t have that now, can we?
Let’s try plan B; instead of discounting, let’s devalue. If we devalue the local currency by 10%, our export product will in effect be 10% cheaper, (for offshore buyers) just like with the discount; our sales should rise, just like before. So far, so good… but what are the ‘unintended consequences’?
Why, first, the import component will now cost 55 NMU (New monetary unit) which has the same value as 50 old MU’s had. If we sell the same product for 100 NMU (rather than 90 OMU), then we need to spend 55 NMU (rather than 50 OMU) for imports, and we only have 45 NMU (the equivalent of 40.5 OMU) for local value added.
Wow; for the same sales as before, instead of getting 50 MU like before the evaluation, we only get to keep 40.5 NMU; we are about as badly off as if we simply discounted 10%. Under a 10% discount, our local value added is 40 OMU… well, at least we are 0.5 ahead… or are we?
What if the locals buy offshore stuff, like say Taiwanese TV’s with their ‘NMU currency’; remember, all imports are now 10% more expensive, as measured in old monetary units. In effect, the local standard of living took a dive. Or, ‘inflation’ took an uptick.
By golly, if this is the case, why do we devalue? Is it possible that our ‘leaders’ don’t give a rat’s ass about how much the real economy suffers… or about the standard of living of citizens, as long as they can keep their power, their perks, and their legal immunities?
Of course, this is the bottom line… devaluation is a sneaky way to hide a loss of productivity, to hide a drop in standard of living… and to find ready scapegoats to blame the ‘inflation’ on; greedy capitalists, speculators, the usual suspects.
New Austrians understand this situation clearly; that is why we consider devaluation to be sheer insanity… and the equivalent of throwing away your bullets before the battle. After all, if devaluation actually did some good, then Zimbabwe should be the most competitive, highest standard of living country in the world… and not the total economic disaster it in reality is.
If devaluation is not the way, what is? Simple; increase productivity, and achieve real competitiveness. Cut ‘overhead’ by cutting the parasites… and accumulate real capital. Real capital means more efficient machinery, more efficient infrastructure, inexpensive energy and a more productive, better educated work force.
Germany has some of the highest hourly wages in the world, yet their unit labor costs are the lowest… because of high capital investment. This is the way it must be, this is the law of economics; savings must come before investment. Debt does not replace real capital; in fact, excessive debt simply leads to capital erosion, and if carried farther, to capital destruction.
Fiat currency is indeed subject to devaluation… and thus capital destruction… but Gold and Silver are not; hence the term ‘honest money’. This is why the world must put Gold and Silver to use as honest money. With the fraudulent practice of devaluation eliminated, capital destruction can be replaced by capital accumulation, and the ongoing drop in standards of living reversed.
Rudy J. Fritsch
Editor in Chief
The Gold Standard Institute