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The world of
policy-making is dominated by Mercantilism and Keynesianism.
Under the
Mercantilist way of thinking, the greater the level of goods exports relative
to goods imports, the better. Or, looking at it from another angle, from the
perspective of a Mercantilist a good policy is one that maximises
the amount of money flowing into the country by maximising
the amount of goods flowing out of the country.
Under the
Keynesian way of thinking, spending drives the economy and recessions happen
when mysterious forces -- sometimes called "animal spirits" -- cause spending to fall by too much. A great example of the
Keynesian way of thinking is Paul Krugman's recent
claim that the global economy would be shifted onto a sustainable upward
trajectory if the governments of the world began preparing for an alien
invasion that never happens. The idea that an economy can be helped by
consuming a huge amount of resources in a totally wasteful manner is
consistent with Keynesian economic theory.
It's not
surprising, then, that a strong currency is anathema to most policy-makers.
Currency strength will make life more difficult for goods exporters in the
short-term, which is the only term that matters to most politicians, and
persistent currency strength will tend to promote saving. In the real world,
saving is the cornerstone of economic progress; but in the upside-down world
of the Keynesian, more saving is bad because it means less immediate
spending.
Due to the
theories that guide their thinking, policy-makers will often panic if their
currency achieves large gains against the currencies of their trading
partners. For example, Swiss policy-makers recently began to show signs of
panic in response to the Swiss Franc's performance relative to the euro. As
illustrated by the following chart, the euro, which had been weakening
steadily against the Swiss Franc for more than two years, commenced an
accelerated decline at the end of June. At its low point earlier this month,
the euro had lost about one quarter of its value against the Swiss Franc (SF)
in only 4 months.
In response
to the performance depicted above, some Swiss policy-makers and influential
business leaders have recommended that the Swiss National Bank (SNB)
immediately set a lower limit of 1.10 for the euro/SF rate and then gradually
increase this limit over time. In other words, the suggestion has been made
that the SNB do whatever it takes to firstly prevent the SF from
strengthening any further and secondly reverse the SF's long-term upward
trend.
We have some
sympathy for Swiss exporters. It must be difficult to remain competitive when
the currency in which your exports are priced weakens relentlessly against
the currency in which most of your costs are denominated. However, any
short-term solution that involves depressing the relative value of the SF is
likely to have dire long-term consequences. The reason is that the only
effective way to change the SF's trend is to greatly increase the supply of
this currency.
The SF's
value relative to the euro will fall if the SF supply is boosted to a
sufficient extent, but the monetary inflation will promote widespread
mal-investment and sow the seeds of an eventual economic bust. It could even
sow the seeds of hyperinflation. The reason is that for the SNB to ensure
relative weakness in the SF it will have to consistently inflate at a faster
rate than the ECB, and the ECB could end up inflating rapidly as it
desperately attempts to hold Europe's monetary union together by bailing out
banks and other bondholders.
The world's
monetary system appears to have degenerated to the point where there are no
good options, meaning that economic hardship lies along every possible path.
However, policy-makers could minimise the hardship
by not entering, or withdrawing, from the 'race to the bottom' in which most
currencies are presently engaged. This would be the best way to protect the
savings that will be needed to fuel sustainable economic growth in the
future.
We advise
against holding your breath while waiting for the current gaggle of
policy-makers to do the right thing.
Steve Saville
www.speculative-investor.com
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