Posted by WARREN MOSLER on October 27th, 2008
“Australia’s central bank has intervened to support the tumbling Australian dollar, but failed to prevent its slide to five-year lows against the U.S. currency and its deepest-ever trough against the yen. “
This intervention has two purposes.
One is to keep the decline orderly, the other is anti-inflationary, as the apparent collapse in the currency is immediately passed through to import prices, which play a major role in domestic consumption.
The problem in using intervention to support one’s own currency is that reserves get depleted before the desired level of the currency is achieved.
One core issue is declining real terms of trade due to falling prices of Australia’s exports vs. the prices of their imports.
The other issue is internal distribution.
Australia digs and exports coal, for example, and the boats return full of consumer goods.
A falling currency alters distribution of consumption to those residents in export industries and away from the rest of the population.
The recent US history:
Over one year ago Paulson successfully got foreign CBs to stop buying dollars.
That, along with rising crude prices, sent the dollar to its subsequent lows.
He did this by calling CBs buying dollars currency manipulators and outlaws, insisting they let markets decide currency values.
This was a thinly veiled ploy to get the dollar down to spur exports, as articulated by the Fed chairman in subsequent congressional testimony.
It ‘worked’ as US exports grew at record pace and US GDP muddled through at modestly positive numbers. (A nation net imports exactly to the extent non residents realize their desire to accumulate its net financial assets, as discussed in previous posts)
It also caused a punishing decline in real terms of trade for the US and a decline in the US standard of living, but that was less important to policy makers than ‘pretty trade numbers’ and sustaining domestic demand via sufficiently supportive fiscal policy.
This all caused demand to fall overseas, as governments were (and for the most part remain) in the dark as to sustaining domestic demand, and their economies were directly or indirectly connected to exports to the US.
After Q2 this year rising US exports and falling non-petro imports broke the back of world economies and it has all come crashing down.
Falling crude prices due to ‘the great Mike Masters sell off’ (that I’m still waiting to run its course, and which last weekÃƒÂ¢Ã¢â€šÂ¬Ã¢â€žÂ¢s OPEC cuts may be signaling), also made dollars a lot tougher to get and created a dollar squeeze on a world that had quietly gotten strung out on dollar borrowings.
Accumulating USD by non-residents to pay off debt in the private sectors is working to strengthen the USD the same way foreign CB accumulation had done.
It is bringing down their currencies and will eventually support foreign exports (at the expense of their real terms of trade, but that’s another story).
The US trade gap will fall substantially for a while as crude prices work their way into the numbers.
But then, should world private sector dollar ‘savings’ get rebuilt via USD debt reduction, make foreign goods cheap enough for US imports to once again start to grow.
A substantial increase in US domestic demand via deficit spending (which should be forthcoming with an Obama presidency and democratic control in both houses of Congress.) can restore domestic output, employment, and US imports, to restore our standard of living to pre-Paulson levels.
If we have a policy that drops energy imports, otherwise we can give it all back in short order.
But that’s all getting ahead of one’s self.
For now, the strong dollar seems to be giving foreign CBs, like the RBA in Australia, an inflation scare even as their economies weaken, housing prices sag, and unemployment rises.
This is typical of emerging market economies- external debt burdens high inflation due to weak currencies (due to debt service from the external debt- they need to sell local currency to meet their external debt payments) high unemployment deteriorating real terms of trade as export prices fail to keep up with import prices.
Again, sorry for the earlier mix-up. Need to get my eyes checked!