Surpluses & Deficits are Hotly Debated – But What About the Currency?
Much has been made of Britain’s current account deficit, which is the amount by which our imports of goods and services exceed our exports. It is a situation that protectionists would love to “do something about”, such as resorting to tariffs in order to redress the gap. But protectionists overlook the fact that one of the main reasons for exporting is to be able to import, and it is clearly mistaken to think of exports as “good” and imports as “ bad”, especially as we cannot control the conduct of our trading partners.
This is just a natural extension of Say’s Law, which states that we produce in order to consume. Yes, I know that’s obvious – but it’s the very antithesis of Keynesian economics, which teaches that production can somehow, magically, be brought into being by stimulating demand, a dangerous myth I exposed in Part 2 of “Understanding Economics in one hour”, still available on Going Postal.
If it were true that a sufficient level of demand is all that is needed to bring the processes of production into play, the world’s most prosperous economies would be those of Zimbabwe, Venezuela and Rwanda – rivalled by all the others that have applied the Keynesian formula and, for some reason, have failed. That reason is certainly not a lack of demand!
The above example typifies the Keynesian ‘AAF’ (arse-about-face) syndrome.
Another piece of his AAF mythology is the notion that sellers determine the prices of goods and services, following closely on the Marxist thesis that prices are determined by the cost of labour. Let’s be clear: in a free market economy, it is buyers who determine prices. Think about it – it’s obvious! If still in doubt, please revise my “Understanding Economics in one hour” on Going Postal.
Now pardon that diversion! Let’s get back to the subject of trade.
Every Trading Nation Must Honour its Debts
While every trading nation has to honour its debts to those with whom it transacts business, it is obvious that at any single point in time there will be an imbalance between imports and exports. Since it is impossible for every trading nation to have a permanent current account surplus, to wish for it is merely wishing to inflict the demon deficit on someone else, which takes us no further.
A current account deficit is simply a label for accumulated foreign debt, which in time must be repaid. If the deficit country is creditworthy the foreign holders of that debt will not be concerned, particularly when the deficit country is using its borrowings to finance the acquisition of capital assets that will work towards reducing the deficit. Therefore, despite all the panic stirred up about the deficit, trading with foreigners is in essence no different from trading with locals, and is always just as beneficial from an aggregate economic point of view.
Paying for our Imports
When a British importer buys German goods he must pay for them in euros. For that purpose he (or his agent, usually his bank) will acquire euros from a German bank, and after settling the bill the German exporter (or his bank) is now a holder of British pounds. What will he do with them?
He can use them to buy British goods, or even UK treasury bonds, or he can exchange them for a different currency – but if, instead, he just sits on them indefinitely he will, just like the retailer who never cashes your cheque, be handing the importer a free gift!
The only legitimate concern for those whose trading partners use a different currency relates to the relative strength of the currencies accepted in exchange for the traded goods. No exporter will accept payment for his goods in a currency that he does not trust due to its volatility and instability in terms of purchasing power, and consequently will not be trusted by his other trading partners either.
At a time when the US dollar was respected for having all the virtues of a “reserve” currency, traders in smaller exporting countries all over the world would insist that payment for their produce, raw materials and manufactures should be denominated in dollars.
Protecting our Currencies
Protecting our currencies is therefore the real issue underlying much of the current debate about future trading relations. The most important favour that trading entities can seek from their governments is to desist from destroying the value of their currency. This is now a universal problem – with central banks hell-bent on destroying the yen, the euro, the dollar and the pound, by conjuring more and more money out of thin air and by deliberately suppressing interest rates. A veritable race to the bottom!
Having a weak currency may be good for certain exporters at a point in time, but that advantage is counterbalanced by a disadvantage to the non-exporting sector of the economy. Furthermore, the deliberate action by a central bank to favour exporters by weakening the currency merely causes prices to rise over time, which eats into the exporters’ margins – until the next round of currency debasement takes effect. And so on. In this foolhardy see-saw there can be no winners.