This past week the G20, a body representing the most powerful economies of the world, met to discuss the continued global recession, currency, and the impact of domestic policies on international trade. A lot of diplomatic speeches and intent only agreements were made about what has become common place in Treasuries around the world, lowering national interest rates in an effort to reduce the value of currency and increase export and trade. It isn’t a new concept, in fact for two decades China has been doing just that in order to dominate the world’s manufacturing market.
The G20 agreed to stop the currency wars, a message sent mostly to Japan who has actively been manipulating the Yen to combat deflation, as well as Europe who has been in talks to cut rates in an effort to reduce the impacts of debt in at risk EU countries. Ultimately each currency market has no fealty to global partners, and will decide their domestic policy as politics deems to appease their citizens (or in some cases oligarchical elite).
Effects From Devaluation of Currency
Missing in the discussion of global trade is the prolonged effect currency manipulation has had, and will have, if continued domestically. In China currency manipulation has meant a country which is growing in economic prowess at shocking rates, but it has also meant that the money workers earn is worth far less. Internally Chinese residents can purchase goods at equitable rates, but abroad only the upper class of residents can afford “high end goods” from overseas. More devastating has been the effect of currency manipulation on the lower class and farmers who remain in communist economies and are falling further and further into abysmal poverty.
The beginning of the currency wars was triggered by the global recession. Actually, the currency war itself wasn’t triggered by anything, it began in earnest as a stop gap measure to provide resuscitation into collapsing financial markets. It then evolved into a uniquely effective tool to reduce the impact of debt and expand foreign trade. Proponents of the measures point to the return of manufacturing in the US as proof that this system is healthier. However the return of manufacturing has as much, if not more, to do with global transportation costs, the slow rise of worker’s rights globally, and a continued desperate job market domestically as it does currency. This is evident when you view where the new manufacturing economy is serving, almost all of the expansion has been to products sold domestically not exported internationally.
Oil prices, and the correlating transportation costs, are growing during a time of economic stagnation globally. The return to economic normalcy for the world’s premier economy (yes this is still the U.S. by far) will only create further demand on oil which means that the impact of transport costs are only going to continue to weigh on the feasibility of off-shore manufacturing. That being the case, it should be agreed, whether currency remains arbitrarily under-valued or not manufacturing domestically is going to grow unless the value of the dollar is dramatically strengthened.
What this means is the water has been proverbially squeezed from the rock.
Real Economy Investment of Cash Flow
At this point the devaluation of the greenback may be causing more trouble than it’s worth. Corporate cash flow has never been higher in this country. In the 1980s, even at the peak of the Gordon Gecko greed culture, corporate profits constituted between 4 and 6% of the Gross Domestic Product. In the 90s, corporate profits grew to 7% by the middle of the decade but R&D investing in growing markets had a clear impact as the economy went digital, ultimately ending in the dot.com bubble. This was not before telecomm and tech giants emerged as long term Goliaths.
In the 2000s, corporate profits grew as capital gains and corporate tax rates were reduced under the Bush administration but resulted in a more perilous collapse into 2007. Unlike the dot.com burst very few new industries rose from the ashes of the economy, at least to date.
Throughout the Quantitative Easing and interest rate cut process, corporations have regained profits and cash flow to historic levels, now at approximately 10% of GDP. Companies have the power to invest back into research, emerging industries, and employees today more so than at any other time in modern history.
What are holding back these investments aren’t the market conditions, as is evident by the healthy profits being made, but instead the uncertainty.
In 1995/1996 what brought back investment and the greatest period of economic growth in our economy wasn’t that a particular tax rate now made it make sense to invest, or that a piece of red tape was removed. The individuals who ran corporations moved forward because the landscape of future economic conditions became clearer and they were ready to be pioneers and test the waters.
The signal was worth much more than the substance.
Stimulus Through Lack of Stimulus
Today, with all of the political obstruction permeating through our partisan atmosphere there is one option that can signal this return to economic normalcy. That is our interest rate and currency policy which remains in the hands of the Federal Reserve.
If we want cash flow to return back into investment, instead of holdings, then the Fed should increase the interest rate an otherwise meaningless quarter percentage point. By comparison our rates in the mid-90s were 5.5% and in the 80s closer to 10%. A quarter percentage point won’t bankrupt or otherwise collapse our ability to pay our debt. It will, however, signal that the US, unlike the rest of the world which continues to see worsening economic conditions, is ready to move on.
The Fed has announced it will not increase rates until we reach 6.5% unemployment. What they aren’t noting is that removing public sector job cuts involved in the austerity measures, something which is completely unrelated to interest rates, would show we are already at 6.5% unemployment in markets effected by cash flow. In other words, if total government jobs had remained at the level in 2008 when the Fed pushed their policies, the current unemployment rate would be 6.5% not 7.8% (approximately 2.5 million public sector jobs).
Increasing the interest rate will announce to the rest of the world that the US is through the worst of it, and that we remain a safe harbor for investment and growth in a pirated globe that only wishes it could recreate its economic diversity, maturity, and creativity.
What we lose in trade competitiveness we will more than gain in new industries that the world has not yet thought of when companies begin growing again. Our greatest advance will be the rise of the dollar which will effectively make the middle class stronger and more stable.
I wouldn’t start shorting the US Economy any time soon. We will recover, and when we do we will continue to lead the world as the only substantive economic super power.