Basic Macroeconomic Relationships
The Quantity Theory of Money
Purchasing Power Parity
Gross Domestic Product
Putting It All Together
Data for Select Countries
Exchange Rate Basics
Pros and Cons of a Strong or Weak Currency
Why Depreciate One's Currency?
Methods for Depreciating a Currency
Definition of Currency War
Definition of the Currency Game
The Disadvantages of Currency Manipulation
Other Comments on Currency Wars
Currency wars have been all the rage lately.
Paul Krugman, is an economist, a Nobelist, in fact, who I respected greatly when I was in graduate school, studying his work on international trade. However, over the past several years, I’ve come to view him as a complete sell-out, and as someone who twists economists (both theoretical and empirical) to promote his own completely tainted viewpoint. In his Feb 15, 2013 NYT blog entry, “Currency War Confusions”, he wrote:
OK, people have been asking me where I stand on the “currency war” issue. My answer is that it’s all a misconception, and it would be a very bad thing if policy makers take it seriously.
First of all, what people think they know about past currency wars isn’t actually true. Everyone uses some combination phrase like “protectionism and competitive devaluation” to describe the supposed vicious circle of the 1930s, but as Barry Eichengreen has pointed out many times, these really don’t go together. If country A and country B engage in a tit-for-tat of tariffs, the end result is restricted trade; if they each try to push their currency down, the end result is at worst to leave everyone back where they started.
And in reality the stuff that’s now being called “currency wars” is almost surely a net plus for the world economy. In the 1930s this was because countries threw off their golden fetters — they left the gold standard and this freed them to pursue expansionary monetary policies. Today that’s not the issue; but what Japan, the US, and the UK are doing is in fact trying to pursue expansionary monetary policy, with currency depreciation as a byproduct. Expansionary policy is what the world needs, so why is this a bad thing?
True, Europe may feel that it’s suffering a loss of competitiveness. But there’s an answer for that: emulate the other advanced countries, and have the ECB join in the expansion. Indeed, if fear of an overvalued euro finally undermines the ECB’s monetary hawks, that’s good for everyone.
When it comes to currency depreciation, right now the only thing we have to fear is fear itself.
Personally, I couldn’t disagree more. I believe that the current “Currency wars”, far from being “almost surely a net plus for the world economy”, instead represent a classic prisoner’s dilemma game, in which the whole world is going to end up much worse off than before, with much higher prices, much higher inflation, and much greater uncertainty in world markets.
This blog entry, “Making Sense of the Currency Wars”, makes this case.
I tried to make the dry basic economics stuff at the beginning as brief as possible, while still being comprehensible. Like most things in life, you have to get through the dry, boring basics before you can appreciate the good stuff. For those of you who are already familiar with the basics, feel free to skip to the latter part of the analysis.