Tuesday, 5 October 2010

Translating a Sophisticated American

Today, on its front page, the Financial Times informed its readers of a “call for new global currencies agreement.”
The Institute of International Finance, which represents more than 420 of the world’s leading banks and finance houses, warned on Monday that a lack of [a] coordinated rebalancing could lead to more protectionism. Charles Dallara, IIF managing director, said: “A core group of the world’s leading economies need to come together and hammer out an understanding.”
So, forty years after that mountebank, Milton Friedman, swore by his mother’s grave that adopting a “free” exchange rate regime between the currencies would cure all the ills of humanity, including the balance of payment problems, we have to come to this: the spokesman for 420 of the planet’s leading banks and financial institutions is calling for some kind of “understanding” in the currency market. You realize he cannot say regulation or currency management. So, he says “understanding”.

(That’s what Friedman said: if currencies float freely, there could be no balance of the payment problem because the currency of the country importing more “goods and services” would depreciate, making imports more expensive and exports cheaper and thus, restoring the balance. Everyone praised the simplicity of his logic. Everyone hailed the genius who at last made the argot of economic discourse plain to common folks. Why, even idiots could understand what he was saying. Ah, how he was made into a hero of his time.)

But as a U.S. official who worked on the 1985 Plaza Accord which made Japan “It” (which eventually took it to its “lost decade”) Charles Dallara knows that “understanding” will carry you only so far. So he wants something more concrete, a “more sophisticated version” of the Plaza Accord, according to the Times. That would include “stronger commitments to medium-term fiscal stringency in the US and structural reform in Europe”. “Exchange understandings are of little use on their own,” he said.

I concur. Understanding is over-rated and exchange understandings cannot be trusted. Ultimately it is the fundamental economic factors in a country that determine the strength of its currency. Walther Funk, president of the Reichsbank — that would be the predecessor to the Bundesbank — also agreed. In a 1940 speech in which he talked about his vision for the “New Order” that was to prevail after the war, he said:
We will use the same methods of economic policy that have given such remarkable results, both before and during the war, and we will not allow the unregulated play of economic power, which caused such grave difficulties to the German economy, to become active again ...Money is of secondary importance; the management of the economy comes first. When the economy is not healthy, the currency cannot be healthy.
Note the difference between Funk’s worldview – it’s a worldview and not a mere economic view – and Dallara’s. The Reichsminister only talks about the economy and its management. Dallara is numb on the subject. And how could he not be? He is the spokesman for finance capital which abhors industrial capital and anything there is to do with building and manufacturing. Dallara’s worldview is that of a Shylock. He wants “medium-term fiscal stringency in the US and structural reform in Europe”. The first one means cutting social security, welfare, Medicare, Medicaid, etc. The second one means prescribing the same for Europe as well, as I wrote here and here.

But, why all the fuss, and why now? Why do Charles Dallara or the IIF care about currencies?

The answer is that the pre-WWII competitive devaluation of the currencies is replaced with competitive interest rate cuts. The Fed cuts the interest rates to zero, so the Bank of Japan cuts the rates to zero, so the Bank of England cuts the rates to zero. The European Central Bank will soon have to follow. These are the “G4” that Mr. Dallar suggests should come to some understanding.

As a result, a massive arbitrage is at works. Funds and speculators are borrowing money at almost zero interest rate in “G4” countries and buying assets in emerging markets. Virtually all the money created through the quantitative easing of the Fed, for example, can be shown to have flown to Asia and Latin America.

You know what that means, or rather, bodes. So does Charles Dallara – and his constituents. Hence, their concern to do something about the crash that will come with the inevitability of night following day if something is not done – and soon.

There is more information in your local newspaper than in most top secret intelligence reports. It is a matter of knowing how to read it.