Friday, August 8, 2008

The Petro-Euro. Exchange Rate Warfare (continued)

I have been unable to post replies to blogs lately. I don't know why. So I continue the discussion on exchange rate warfare here.

YouNoSneaky has queried the very existence of an over-valued US dollar.
Discounting very recent declines, the US dollar has been over-valued for a long period of time. Probably (at least) since the early 1960s. That has got to do with the petro-dollar (1973) and global reserve currency (1948) arrangements.

"...At present, approximately two thirds of world trade is conducted in dollars and two thirds of central banks' currency reserves are held in the American currency which remains the sole currency used by international institutions such as the IMF. This confers on the US a major economic advantage: the ability to run a trade deficit year after year. It can do this because foreign countries need dollars to repay their debts to the IMF, to conduct international trade and to build up their currency reserves. The US provides the world with these dollars by buying goods and services produced by foreign countries, but since it does not have a corresponding need for foreign currency, it sells far fewer goods and services in return...." [1]

'Reason' correctly points out that Germany does not have a trade deficit. However Germany is the core of the Eurozone.

"...Getting a share of this economic free lunch has been one of the motivations, and perhaps the main motivation, behind setting up the euro2 . Were the euro to become a reserve currency equal to, or perhaps even instead of, the dollar, countries would reduce their dollar holdings while building up their euro savings. Another way of putting this would be to say that Eurozone countries would be able to reduce their subsidy to American consumption and would find that other countries were now subsidising Eurozone consumption instead...."[2]

The Eurozone does has a trade deficit.

World trade in today's context is dominated by (i) European and US multinational corporations (ii) these same multinationals enjoying monopoly market positions within nations and (ii) trading occuring within the same corporations (or networks of) across national boundaries. Given this, the question of global exchange rate wars between these two powerful camps - the Eurozone and the US - needs to be explored further.

Stefan Karlsson also points out that a net outflow of Foreign Direct Investment (FDI) from the US combined with a large inflow of foreign capital into the US is a very good deal for America [BR: or is it really for US multinatinals??], since this means that Americans can get money very cheaply from the Asian central banks and invest them in high-yielding investments in Asia. [This is] the mechanism behind the fact that America, despite the build-up of net foreign liabilities ..has had a surplus in net investment income of roughly $30 billion during 2004. The fact that foreigners have $11 trillion in U.S. assets versus U.S. holdings of only $8 trillion of assets outside America is thus more than compensated by the fact that U.S. investments offshore have a much higher average yield than foreign investments in America. It is not America who loses when the Asians lend money at low rates to Americans who can then invest it in high-yielding investments in Asia.”[3]

[1] 'Petrodollar or Petroeuro? A new source of global conflict.' By Cóilín Nunan. Accessed on 8th August 2008.

[2] 'Petrodollar or Petroeuro? A new source of global conflict.' By Cóilín Nunan. Accessed on 8th August 2008.

[3] What Are We to Make of the Trade Deficit?
Daily Article by Stefan Karlsson | Posted on 3/21/2005


YouNotSneaky! said...

Well, these "very recent declines" are sort of important aren't they (currently being in UK I'm definitely feeling their sting)?

Also, how can a floating currency be "over valued"? Relative to what? PPP?

Finally, in terms of monetary policy, the exchange rate is way way down on the list of the things that the US Fed cares about. If it's actually on there.

Myrtle Blackwood said...

" can a floating currency be over-valued?"

Firstly, the act of floating currencies does not guarantee that any particular currency will be free on inappropriate valuation. Secondly, in the case of the US dollar it's 'value' has been artificially set (much higher than it should be) by it being linked to global trade in oil. This arrangement is now being shared with the Euro. See the following article for a timely explanation:

The Proposed Iranian Oil Bourse, by Dr. Krassimir Petrov
Global Research, January 20, 2006

"the exchange rate is way down on the list...[for the] US Fed.."

Quite the contrary!

"...from a purely economic point of view, should the Iranian Oil Bourse gain momentum [and thus resulting in a decline in the value of the US dollar], it will be eagerly embraced by major economic powers and will precipitate the demise of the dollar. The collapsing dollar will dramatically accelerate U.S. inflation and will pressure upward U.S. long-term interest rates. At this point, the Fed will find itself between Scylla and Charybdis-between deflation and hyperinflation-it will be forced fast either to take its "classical medicine" by deflating, whereby it raises interest rates, thus inducing a major economic depression, a collapse in real estate, and an implosion in bond, stock, and derivative markets, with a total financial collapse, or alternatively, to take the Weimar way out by inflating, whereby it pegs the long-bond yield, raises the Helicopters and drowns the financial system in liquidity, bailing out numerous LTCMs and hyperinflating the economy...."

[From the article mentioned above]

YouNotSneaky! said...

"inappropriate valuation"

What determines what constitutes a "inappropriate valuation" for a floating exchange rate? Is it anything other than a particular value that someone somewhere doesn't like for some reason?

"the US dollar it's 'value' has been artificially set (much higher than it should be) "

Set by whom? What determines how much it "should be"? What does "artificial" mean in this context?

Right now, feeling the pinch of having to purchase stuff in pounds I happen to agree that it is "inappropriately set". Inappropriately set too low! Someone should get on that and fix it before I'm reduced to eating egg and mayo sandwiches!

"being linked to global trade in oil"

This really doesn't matter that much.

"Quite the contrary!... (excerpt from the article)"

The link to the article doesn't quite work. But just judging from the part that is quoted, it is essentially composed of a whole lotta groundless speculation, it confuses cause and effect (for example between the inflation/exchange rate/interest rate channels) it assumes that the Fed acts in ways that it does not act (if you want to know how it acts you look at domestic inflation and unemployment. There has been NO relationship between exchange rates and Fed policy pretty much since, well at least mid 80's and more like 1973) and frankly reads like it's tinged with conspiracy mania.

(Having said that, the fact that the Fed might find itself in a bind with no good way out, as described in that paragraph may be true. But this has little to do with an "overvalued dollar")

Myrtle Blackwood said...

"what constitutes a "inappropriate valuation" for a floating exchange rate?"

When the 'demand' for a currency is artificial. For instance when a nation uses a degree of force or other form of threat against another nation in order to force the sale of commodities in only one currency. That of the dominating country.

"1971:...John Connally (Nixon's new Treasury Secretary appointed on 11th February 1971 and former Governor of Texas) set up the big 'Business Roundtable' The new rules of government were placed entirely in the service of the largest US corporations:

- less and more government (depending on who benefits)
- lower taxes for business
- lower wages (dismantling the unions through corrupt secret ballots etc)
- deregulation of industries such as transport, finance, energy, telecommunications.
- internationally the US government was to intervene to ensure expanded markets for US corporations (for sales and production).
- a mercantilist advantage in the US with a favourably-weighted dollar...

[From Richard Parker's biography of John Kenneth Galbraith]

BR: "the US dollar it's 'value' has been artificially set (much higher than it should be) " YNS: Set by whom? What determines how much it "should be"? What does "artificial" mean in this context?

"In 1971, as it became clearer and clearer that the U.S Government would not be able to buy back its dollars in gold, it made in 1972-73 an iron-clad arrangement with Saudi Arabia to support the power of the House of Saud in exchange for accepting only U.S. dollars for its oil. The rest of OPEC was to follow suit and also accept only dollars. Because the world had to buy oil from the Arab oil countries, it had the reason to hold dollars as payment for oil. Because the world needed ever increasing quantities of oil at ever increasing oil prices, the world's demand for dollars could only increase. Even though dollars could no longer be exchanged for gold, they were now exchangeable for oil...

The Proposed Iranian Oil Bourse
By Dr. Krassimir Petrov
Global Research, January 20, 2006

YNS: "Right now, feeling the pinch of having to purchase stuff in pounds I happen to agree that it is "inappropriately set". Inappropriately set too low!.."

The Iranian Oil Bourse opened in February this year. "It [is] based on a euro-oil-trading mechanism that naturally implies payment for oil in Euro. In economic terms, this represents a much greater threat to the hegemony of the dollar than Saddam's, because it will allow anyone willing either to buy or to sell oil for Euro to transact on the exchange, thus circumventing the U.S. dollar altogether. . .

This is one of the reasons why the US dollar has dropped in value. Because nations can now purchase oil in Euros. There are other reasons this has happened as well (which I won't list tonight) but much of it has to do with the mismanagement of the US economy and its governmental system.

BR: "being linked to global trade in oil"

YNS: "This really doesn't matter that much."

I believe the implications of this link have not been examined carefully enough. As oil becomes scarcer, the sale price increases. This sets in motion the need for countries around the world to engage in greater and greater exploitation of natural resources as well as workers. The petro-currency arrangement is likely to be the major reason why the US has not moved to establish technologies that use alternative forms of fuel, in order to prevent climate change. etc.

Try the link again, it should work.

"There has been NO relationship between exchange rates and Fed policy ..."

That is simply not true. The level of interest rates set by the Fed affects the exchange value of the dollar.

YNS: [The Fed's bind] has little to do with an "overvalued dollar"

Again, that is simply not true. The high levels of unsustainable consumer and mortgage debt in the US were, to a significant extent, a response to the working out of the effects of an over-valued dollar on the US and global economy over some decades.

Ken Houghton said...

YNS - Short, counter-question.

It is well-known in finance that, for instance, on-the-run securities trade at a higher price than they should simply by their being defined as "on-the-run."

Similarly, the 10- (in the old days, 30-) year security, as the "baseline" for the concept of "risk-free rate of return" has always been known to trade at a premium to its "fair" price simply because of "artificial" demand. (Artificial here in the sense of, when it ceases to be the OTR/current security, its price drops more than just the curve value.)

Similarly, a pint is no longer "a pound the world around," and the precipitous drop of the quid when it was replaced as the "international currency" by the USD argues that currency markets follow the same example.

Why would the 2008-era USD be different from the ca.-1920-era UKL/GBP, if the general world currency became the EUR?

(In noting historic parallels, the UK trade balance for the two decades before WW I ended any hope of its retaining supremacy would be notably negative save for "intangible" values.)

Anonymous said...


I think that Michael Hudson made the argument in the early 1970s and then again in 2003 that the world is on a 'U.S. Treasury bill standard' that, by my recollection, means a process of dollar recycling in which surplus nations, in order to keep their economies turning over, have no choice but to fund U.S. deficits, so also support dollar hegemony. The second support is, or at least was, U.S. military power, which the first helps pay for.

In a sense this might be seen as having been a giant subsidy to capital-in-general but moreso that of the center and the largest firms, recalling that capital has no nationality.

This has been a more complete structure than enjoyed by the British Empire but, as Ken implies, cannot be permanent.

BTW, dollar valuation in the modern era has more to do with currency traders' perceptions and the types of algorithmic/automated trading used than fundamentals or central banks.

Myrtle Blackwood said...

Thanks Ken and Juan for the information. I'll check this out further as time permits.

Juan, aren't "currency traders' perceptions" heavily influenced by the power that the US Government and its corporations yield?

Fungus the Photo! said...

I am about to get myself barred from this site, but in reality, your fetish that economic warfare has to conform to rules is laughable!

You are all "at it"!
"Rules? We don' need no stinkin' rules!"

The world has been engaged in warfare. Wake up! The rules only apply if you don't control the media. Once that is established, (use people who are allowed to have monopoly then TPTB control them and can shut them down whenever) it just rests on finding a country that wants to attack the world's greatest superpower. Not hard seemingly! Usually if they have oil (but Viet Nam seems to be an anomaly?)then they are worthwhile deploying troops. More assets then end up in the coffers.

This is piracy, not economics!

If you chatterers are any example of high minimum wages, tertiary "education" for any with half a brain, then maybe the Chicago school are correct to keep an underclass in existence?

Economics after all is merely the naming of parts of our environment. Just because Nobel had the money to waste on a Prize Fund doesn't mean that economics contributes anything to humanity.

I strongly suggest economics merely allows the indolent to be able to afford Starbucks while confusing the mob!