So far, the USD has been valued high by the FCBs (inorder to export to US). When the deflation hits worldwide, how can these FCBs mitigate the pain in their economies? Simple. If they print more of their money, then they will induce higher PPI - hence higher unemployment because CPI is falling (or atleast there is monetary deflation). [I believe deflation is not easily curable because printing more money only causes more pain - and hence printing money is not the cure - otherwise every central bank will love deflation!!]. Printing local currency will cause slightly more pain!! The only other way is to spend the USD savings they are currently holding!! i.e the foreigners spend the dollar more acquiring raw materials like OIL - and the US industry will have to work hard now to pay for the foreigners purchase of oil etc! i.e the inflation in PPI will then show up in US and not in FCB's economies!! (the inflation happens in whatever currency is released into the market).
Just as USD printing (monetary inflation) now, did not cause very high PPI inflation in US (because FCBs removed the money from circulation, however inducing spending through lower interest rate), monetary deflation that is coming will cause the exact reverse i.e more money coming into circulation from FCBs spending US Treasuries to prop up their economy even though there is monetary deflation!! i.e even if no new money is created, lot of money will be coming into circulation!! This will cause interest rate spike curtailing the spending - just as current monetary inflation does the reverse. When deflation hits, it is payback time!!
Many people think when deflation hits, FCBs will try to keep their currencies down to export to US (status quo). But in reality, when the recession hits, people stop buying everything except life saving items!! i.e US consumers will stop buying Oil in large quantities - instead they will go in bicycle or public transport!! This would be the case in both US consumers and foreign consumers. However, both the US producers and Asian producers need OIL to drive the industry!! These industries will be running to serve LOCAL CONSUMERS and not foreign consumers!! By the time deflation hits, Asians will no way be able to afford American Services just as Americans dont need Asian goods and services!! EVERYONE in the world will consume just the necessities which are ALL LOCALLY produced even today (like electricity, toilet paper, water, food etc). Asia wont need America's heavy equipments from Caterpillar, Boeing etc and vice versa!! Then, how can Asians save their economy? Lower the cost of production for their industry - the easiest way to do this is to let the currency appreciate!! So which currency will appreciate? Anyone who has foreign currency to dump will appreciate. i.e These countries that saved for the rainy day will dump their foreign currency (be it Euro or USD or yen) - and because currency exchange is based on supply and demand - there will be more supply of Euro/USD and hence they all fall against Yuan and trade surplus countries.
Apparently, I read a few articles that China is already worried about commodity inflation and it tried to manipulate the prices lower (as in Copper in LME and oil in Singapore commodities market)! It back fired!! So they really understand that lower inductrial prices (PPI) is the key to massive supportive programs by govt!! They will appreciate their currency as high as possible - when deflation, trade friction all hits the ceiling.
Apparently, in 1930s, there were many currency blocs and that is why Bretton Woods was signed to enable division of labor across the borders of countries!! Just a final food for thought: Suppose in the deflation, USD falls 80% against yuan, then that mere currency fall will push China's GDP close to US GDP!! i.e China will move from 3rd to 1st economic power very soon!! Then, they will be able to support Yuan as a hegemony currency - in whatever bloc/World they chose to allow that!!! People are wrongly deluding that it will take till 2050 for China to overtake US. Imagine what currency depreciation can do!! In the 1930s, pound fell more than 65% against gold/USD and England was trying hard not to allow that depreciation by keeping higher interest rate!! i.e even though they printed money - since getting out of gold standard - their currency depreciated causing positive PPI even thoug there was commodity deflation in USD/Gold!!! That is the cost of going off of gold standard and the US enjoyed the benfit of low interest rate because of the gold standard. People fail to understand the benfit of gold standard (or holding currency reserves as in USD today) in deflation!!
One more final scary thought: In the early 90s, everyone was scared that Japan is going to overtake US - because they are "HIGH TECH". Looking back, all their high techs were phones and entertainment systems!! Just simple gadgets - nothing to be scared of!! Today US is making communication chips and softwares and CPU chips. But 10 years from now, these will be commodities and China makes ALL of them today at 1/10th the price of US!! People are deluding again that, US's technology can never be matched by China!! Already China made Avian Flu vaccines (Atleast much advanced than US!) |
