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Prosperity, Competition, and the Exchange Rate

Prosperity, Competition, and the Exchange Rate

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Published by John Griffiths
Explains the workings of the Floating Exchange Rate System, & how it & Deregulation impact on an economy e.g. High exchange rate's threat to nation's competitiveness. Has Australian, US & EURO examples.
Explains the workings of the Floating Exchange Rate System, & how it & Deregulation impact on an economy e.g. High exchange rate's threat to nation's competitiveness. Has Australian, US & EURO examples.

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Published by: John Griffiths on Apr 08, 2012
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12/06/2012

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PDF download version of 
http://www.davidbrown1801nsw.info/fLoatimpactcompetition.html
 
A brief look at the impact of Central Banks, Floating Exchange Rate System, & Deregulation of Banking on an Economy
Page 1 of 
10
 
Prosperity, Competition, and the Exchange Rate
 
1
.
T
he high exchange rate's threat to the competitiveness of the nation’s products;the loss of industries and the jobs they represent;the threat to national prosperity if exports are put at risk; anda mounting current account deficit;
are issues of concern that have often arisen in Australia over the last several decades. The concern is valid and theissues real.They are issues that can be resolved. To begin to appreciate how requires a basic understanding of the'floating' exchange rate system (
also known as 'the float’
) that links them.
Isolation of the Money Supply
2.The float, a market determined, variable exchange rate system, was adoptedby Australia in 1983
(
adopted in the US March 1973
). It was designed byMiltonFriedmanto 'buffer' the disruptive effects of ‘external trade shocks’ on aneconomy.
1
To do this, the float isolates an economy’s money supply so thatno money can leave or enter. The extent to which it succeeds in its bufferingrole is debateable. Nevertheless, the float is effective in isolating theeconomy’s money supply. 3..-To ensure that the money supply does not change, the exchange rate rises and
The float isolates the money supply
 
falls to balance the flow of currency each way - Hence its' description 'floating'. Payments for imports and othercurrent items such as interest on foreign debt must be balanced with foreign receipts from exports and investments.However, payments and receipts being in balance means there is nothing left over - There is no surplus from exportearnings to add to national savings!4.
 
Prior to adopting the float, money earned from exports added to national savings in theform of accumulated foreign reserves.
2
 When converted to domestic currency, thosereserves added to the economies money supply and fuelled growth in the domestic market,and the economy as a whole. Not so, under Friedman’s float - Incoming foreign money isspent on imports and other foreign commitments, and leaves the economy.Exporters arepaid, butno matterhow much is exported, they cannot add to Australia’s existing moneysupply.
3&3a
That is,
under the float
,
exports bring no additional wealth to the nation
!
 An alternativevariable exchange rate system would allow exports to add wealth.
 
Two-speed or Pear-shaped Economy
5. The present arrangement of no added money or growthfrom exports seems an especiallyunfortunate consequence of government policy. To this adversity, the float addsanother!Rising exports increase the amount of foreign currency trying to enter theAustralian economy as export earnings. That drives up the exchange rate for theAustralian dollar.A rising exchange rate inevitably makes imports cheaper thanequivalent goods and services produced in Australia. This causes our domesticindustries, and jobs associated with them, to be made uncompetitive and progressivelysqueezed out of existence.
4
The more we export, the more we have to import. Themore we import, the more we undermine our domestic industries.
5
#It is the same fortheUK. In the USA, the product of this kind of occurrence is known as the 'Rust Belt’.
 An alternative, variable exchange rate system would allow Australia’s domesticindustries to be competitive and prosper!
 6.
Isolation of the money supply interferes with, and distorts, the demand and supply mechanism
of aneconomy. Demand skews to favour imports as supply skews to focus on exports. It is in effect an interference in,and distortion of, the market! That distortion diverts the economy’s wealth away from domestic industries toexporters. Investment in capital equipment tends to reflect that trend. Australia’s export industries such as mining,
 
 
PDF download version of 
http://www.davidbrown1801nsw.info/fLoatimpactcompetition.html
 
A brief look at the impact of Central Banks, Floating Exchange Rate System, & Deregulation of Banking on an Economy
Page 2 of 
10
 
wood chipping, and 'live cattle to Indonesia' to do very nicely and expand at the expense of the nation’s otherproductive industries and jobs.
6
 7. A classic example of the diversion of wealth phenomenon is WesternAustralia’s mining boom that causes it to be seen in stark contrast to themore economically challenged south-eastern states. This is the so-called 'two-speed’ or ‘multi-speed economy' effect, which has oftenbeen extolled as a blessing by those unaware of the true circumstances.#It is a phenomenon also evident in the European Monetary Union(EMU). It has benefited the great exporting nation, Germany, withpositive Current Account Balances over the last 10 years that aremirrored as negative balances for GIPS countries (
Greece, Italy, Portugal,and Spain)
. Paul Krugman’s diagram below illustrates the ‘Two Speed’(diversion of wealth) effect of the float. Some believe that the GIPScountries are detrimental to the survival of the EMU, and that thedeparture of one or more of them from the union can save the euro. Butthat would cause the debilitating burden that is being borne by those
‘the float ….interferes with, and distorts, the demand andsupply mechanism’ of an economy
(causing it to go pear- shaped. S 
ee Fig 1 below).
 
countries to pass on to the next most vulnerable EMU members. They in turn would succumb and leave. As theEMU steadily shrunk, the currency exchange rate for Germany’s export goods would rise,and make theirdomestic industries less competitive against imports. The ‘rust’ contagion already evident in Germany’s industrialregions would spread. 
(
Saving the Euro
http://www.buoyanteconomies.com/SavingTheEuro.pdf refers)
More recently, the growingconcern about GIPS countries’ debts has been causing downward pressure on the euro exchange rate, and in theprocess making Germany’s exports more competitive.
Thanks to the float, Germany’s prosperity is tied tosurvival of the EMU. Similarly, Western Australia is dependent on the rest of Australia.
 
Fig 1 – Germany and GIPS Countries Mirror Reverse Current Account Balances
(
Wishful Thinking And The Road To Eurogeddon, The Opiinion Pages, NY Times 7 Nov 2011
refers).
Growth of Debt and its Distortion of the Market
8. As indicated in the opening paragraphs, in adopting 'the float', Australia denied itself the ability to stimulate itseconomic growth through the accumulation of foreign reserves (
national savings
) that can be earned by exports.The Australian currency released into the money supply in exchange for those accumulated foreign reserves had
 
enabled economic expansion. However, removing this facility for economic growth meantthat the only other significant source of money available to the economy was from the growthof bank credit; that is, by going into debt.
7
In 1984 and 1985, to stimulate its economy, theAustralian government deregulated the nation's banking industry. This allowed the nation'sexpenditure to be no longer constrained by its income.
7a
Thus the banks have been creatingmoney for which there is no prior entitlement
(i.e. it is
‘unendowed’
or unentitled 
) to thenation’s productive capacity – Moneythat no-one worked for or saved.
8
 It is
excess moneythat has caused demand to outstrip supply and further distort the market
. As a result, Australians haveincreasingly spent future national earnings in the present. For the Banks, ‘things have never been so good’.
 
 
PDF download version of 
http://www.davidbrown1801nsw.info/fLoatimpactcompetition.html
 
A brief look at the impact of Central Banks, Floating Exchange Rate System, & Deregulation of Banking on an Economy
Page 3 of 
10
 
Fig. 2
Australia Bank credit, the current account, and fiscaldeficit
 
-
 per 
http://www.buoyanteconomies.com/AustCADMoney.htm
 
12
 
Fig. 2a
Australian CPI
(Inflation)
 
&
Monetary Pressure
(Square root of 
change in
Unendowed Money
over change in
GDP
)
10b
 
http://www.buoyanteconomies.com/AustInflation.htm
 
9.
Deregulation of the banks has enabled Australia and other G-20 countries to buy more than they have produced.That is, unrestrained bank lending (
backed by foreign capital
) has caused them to import more than they haveexported.
9
It is
a corruption of the market mechanism
that imposes significant distortions on a nation’s wholeeconomy. Those distortions include a corresponding growths in the:
current account deficit
(
see Fig. 2 above
),
persistent trade deficits
(
see Fig. 6 below
),
inflation
(
see Fig. 2a above)
, and
foreign debt
.
10#
The lawdiscourages forgers because of this kind of damage to the economy that their unendowed money can produce.However, banks the do the very same thing with their ‘unendowed’ money!
 
Inflationary Madness
10.Uncomprehending or in disregard of these various systemic distortions, G-20 central banks worldwide are eagersupporters and facilitators of the deregulation and the float. Perhaps not surprising, given these instruments of monetary policy are designed to favor the profitability of banks, not benefit the economy as a whole.
 
10a. Indicativeof G-20 central banks, the
Reserve Bank of Australia
(RBA) makemuch of ‘inflation’ rather than ‘exchange rate level’ being the prime target of monetary policy.
10a
However, as Fig.2a testifies, RBA’s battle to rein-in inflationis ineffective. Significantly, the values for money price pressure show a strongcorrelation with CPI over nearly three decades - But exchange rate and fiscalpolicy has not had any noticeable impact on that relationship.11. For their assault on inflation, RBA
(
indicative of other Central Banks)
utilise the variable exchange rate toencourage cheap imports into the Australian economy and drive down domestic industry prices. Towards thisend, RBA chooses not to ‘target’ or limit the level to which the exchange rate rises. From time to time, RBA hastraded currency to adjust the exchange rate in keeping with this strategy. Theirmaintenance of high interest ratesthat attract foreign investment has also played its part in driving up the exchange rate and making importscheaper.
17
However,
RBA’s advocacy on behalf of foreign suppliersis unnecessarily generous
, given that itbenefit in controlling inflation. RBA’s encouragement of high exchange rates also accentuates the two speed(
transfer of wealth
) distortion of the Australian economy. The consequent loss of Australian industries and jobs is not only an unnecessary and costly waste, it alsoundermines the nation’s productivity.
17
a
Typical of other G-20 central banks,RBA dismisses these victims of its policies as being incompetent and inefficient.More obvious, especially to exporters, is the high exchange rate’s inflationaryand anti-competitive impact on the price of Australian export products, and theircomponent costs such as labour. RBA’s obsession with a ‘strong’ butuncompetitive Australian dollar is taking its toll. If collateral damage is to beregarded as irrelevant, then the method in this madness can be rationalised -
RBA’s unrelenting destruction of the economy’s productive capacity, takento its not so logical long-term conclusion, will certainly eliminate inflation.
 

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