Monday, 13 August 2012

The pernicious effect of an over valued exchange rate.

Exchange rate distortions are at the very core of the current global crisis.   It is form them that everything else that is wrong arises – worse even than the debacle that is global banking.

Floating exchange rates are meant to reflect relative efficiency of the respective trading economies a weak and inefficient economy will have a very low valued currency while an efficient economy will have a high valued exchange rate.

There are two problems with this.  It only works if everyone is playing by the same rules and if there isn’t anyone gaming the system.

Unfortunately we have some economies that have rigged fixed exchange rate mechanisms that tip the balance in their favour.  We then rely on an infrastructure of global finance to operate the system.  Unfortunately those who operate the system run it for their own benefit when it needs to be run for the common interest of those who trade in goods.

Parties who trade internationally are using a system of currency exchange that is run by parties who are not just betting against them but who are actively interfering in with the demand for money.  These parties are doing an ENRON but with money.  They withhold money or flood money into individual markets to drive the price up or down and then bet on the consequences when they reverse their positions.  The fact that 95% of all foreign currency trades of the $NZ are for speculative purposes is illustration enough but when the absolute scale of this activity is included it becomes clear how corrupt this system is.  The daily trade in NZ currency is equal to half the country’s annual GDP.  This is crippling our ability trade as it imposes a huge cost to our export sector.  

It is also sending us broke.

It is also how our Prime Minster got rich.  He didn’t work hard, he didn’t create some innovative product, he didn’t add value to any process; he was just a filter feeder in a system run by filter feeders.  His wealth he skimmed from those who were working honestly in the field of international trade.

The deeper problem is the lack of a common set of rules for managing currencies. The true villains at the core of the current round of economic crisis are Germany and China.  Each have set up relationships with client states that contained an entrenched fixed currency imbalance in their favour.  The European Currency Union acts as a subsidy on exports for Germany and tariff on imports while it acts the other way around for all other countries in the EU.

Similarly China has had a pegged currency against the dollar for the past several decades.  Japan did the same thing for as long as it could.  These resulted in huge transfers of wealth from the overvalued economy to the undervalued economy.  Why the US and the rest of us have put up with it for so long is truly surprising as it is such an obvious and damaging yet simply rectified distortion.

As with all distortions when it does resolve itself the rectification will be rapid and hugely disruptive.   It will be like an overstretched rubber band - it will either snap or snap back - either way it will be a rapid and violent reaction.


  1. Gidday

    A role for some sort of transaction tax perhaps to take the edge off the speculator's margin?

  2. Hi Andrew - great to meet you - sorry the discussion wasn't more extensive

    Yes you are right one way to sort this sort of behaviour is to add a tax as a braking device to add sufficient friction to negate the incentives for the speculative behaviour. It may aso be desirable to tax windfall currency trading gains at a punitive level - this wont however overcome the fundamental structural issues caused by the Euro and China's pegged currency and the fact that all of the oil nations trade in the US dollar rather than their domestic currencies.

    We need a "pegged to a basket" approach with the dollar - not totally fixed but moving with our trading partners -sn=and it needs to have a substantial reduction in relative values urgently -basically our exchange rate should be set in a way that recognises the amount of surplus capacity in the economy - if as now we have a lot of surplus capacity and we are borrowing to import at the same time then our currency is clearly overvalued. We are subsidising imports and penalising exports