Dear Mr. Calhoun,
Thanks for your e-mail and for sharing with me your response to my article.
I am sorry that my article was read as advocating increased currency market intervention for that was not its purpose. Its purpose was to make the case that what we need today is a more rules-based system than we have at present as well as better macro-economic policy co-ordination among the major economies. In particular, countries should not be allowed to manipulate their currency for competitive advantage through large scale foreign exchange intervention (China) or through keeping interest rates artificially low (Japan). If we are to have a floating exchange rate system, countries should simply not be allowed to engage in persistent one-way market intervention that thwarts the international adjustment process.
In my view, today’s unprecedented large global payment imbalances pose a real threat to world economic prosperity. In particular, their disorderly unwinding (as in a dollar crisis) could add to financial market instability and could trigger protectionist pressure in much the same way as occurred in the 1920s and 1930s.It is also my view that the unwinding of these imbalances would best be effected through coordinated policy action by the world’s major economies.
To be sure, probably the most important part of today’s payment imbalance problem is the paucity of savings in the US. However, if the US is to reduce its payment imbalance without inducing a domestic recession, it will need to engage in both “expenditure reduction measures” through monetary fiscal policy action to increase savings as well as in “expenditure switching policy” through having the US dollar depreciate. In the absence of a revitalization of the US traded goods sector, expenditure reducing measures alone can correct the US balance of payments problem but they would do so at a great cost to US and global economic growth.
For the US dollar to depreciate, foreign countries have to let their currencies appreciate and they have to restrain themselves from thwarting the adjustment process. At the same time, they have to engage in stimulative spending policies to create the demand necessary to replace the boost that their economies were receiving from their trade surpluses or from US profligacy.
I fear that we are living in a world in which each country follows domestic policies without consideration to the impact it might have on the countries with which it trades. We went down this road before in the inter-war years and the end results were not pretty.
I hope that this clarifies my thinking.
Dear Mr. Lachman,
First, let me say that I appreciate your thoughtful response. One never knows how someone will respond to criticism, especially these days.
I’m still having some trouble understanding what you propose however. You say that we need a more rules based system than we have at present, but won’t that mean, by definition, more government control? When I say government intervention, I don’t mean just direct intervention in the trading of currencies. There are many ways that government can intervene in the proper functioning of a market. In your rules based system, who gets to make the rules? Also, don’t you think that countries that attempt to manipulate their currencies will generate their own internal problems as a result? China would appear to be importing our inflationary monetary policy and the result is a property and capital spending boom that will eventually resolve itself (and probably not in a pretty way). I also wonder what would happen to the yen if the low interest rate policy were ended. My guess is that the yen would further depreciate as the Japanese economy weakened with higher rates. I have found in my years of trading that the easy answer rarely works. One would think higher interest rates would result in a stronger currency, but that is not always the case. In my opinion, Japan needs a dramatic change in fiscal policy (reduction of deficits, deregulation, tax cuts) to emerge from their deflation. Monetary pumping has had little effect and I don’t think it ever will. For sure it’s had effects outside Japan (through the carry trade and export of domestic savings), but I think that reflects the lack of good investments within Japan. That’s what they need to change; monetary policy cannot overcome the low returns on capital when capital is free to leave for greener pastures.
I agree that the current conditions cannot last forever, but I have doubts about how close we are to a “disorderly unwinding”. I also share your worries about protectionism, but it seems more likely to me that the protectionist measures could be the cause of the “disorderly unwinding” rather than the result of a dollar collapse. Why would we need protection after the dollar collapses? Politicians like Graham and Schumer would presumably be pleased with a much cheaper dollar.
I don’t believe that depreciation of the dollar will accomplish your goals in any case. How far would the dollar have to fall to make the traded goods sector in America competitive with China and other low wage countries? As long as globalization continues (and I think it is a moral imperative that it does), there is little chance that we can devalue our way to prosperity in manufacturing. If we can’t lower wages enough to compete and we can’t raise productivity enough to compete, it seems to me that our only choice is to raise the return on capital to induce more saving. Why not eliminate or drastically reduce corporate taxes? Why not eliminate capital gains taxes? Maybe if we stop punishing people for investing/saving they will do more of it.
As you may have guessed by now, I don’t have a very high opinion of governments and their ability to manipulate economies. The end of Bretton Woods was indeed ugly, but was that because we enacted domestic policies without considering the impact on our trading partners? I think it is more factual to say we enacted political programs (The Great Society programs) without considering or judging correctly the impact on our own economy.
We are continuing the debate and I will post a followup soon. I would like to note that Mr. Lachman has been very gracious in sharing his views with us. The goal here is to learn and become better investors. I don't care how long one has been at this, there is always more to learn. It's nice to be able to debate a serious topic in a serious way. Too many in the blogosphere seem to think that if you don't agree with them you are not worthy of a thoughtful response. Mr. Lachman is a gentleman.