Tuesday, February 19, 2013

Fighting Wars on Two Fronts

In World War II, we fought a two-front war in both Europe and the Pacific. The War on Terror saw us fighting on two fronts-in Iraq and Afghanistan. Looking at the latest news we seem to find ourselves in another two front war that involves both cyber warfare and a currency war.

A report released today indicates that China's government has been systematically involved in cyberwarfare against American interests according to this story in the International Business Times.

China’s government is behind a vast, sophisticated campaign of cyberwarfare, according to private U.S. investigators and confirmed by Washington, a report published on Tuesday said.

U.S. security firm Mandiant, which was hired by the New York Times to investigate breaches of its own security, provided an advance copy of the 60-page report to the newspaper. The report describes how the People’s Liberation Army launches attacks against American companies, organizations and government agencies from or near a 12-story building on the outskirts of Shanghai.
The group behind the attacks is P.L.A. Unit 61398, whose main office is on Datong Road, outside Shanghai, but victims of its attacks call the unit the “Comment Crew” of “Shanghai Group,” the New York Times said.
Targets of Unit 61398 include agencies and companies whose databases contain vast and detailed information about critical U.S. infrastructure, including pipelines, power generation facilities and transmission lines.
The Obama Administration is supposed to unveil some type of actions and defenses against this activity  tomorrow.  In my view, it is time to get really tough with the Chinese especially if it is proven this is the work of the Chinese government.  What would our reaction be to a physical attack on our pipelines or power grid by the Chinese?   We might even have to tell them that we won't let them loan us any more money!  Therein, lies the problem.  We have let us ourselves become dangerously dependent on Chinese goods, money and materials.  In Proverbs 22:7 it is stated this way,

"The rich rule over the poor, and the borrower is servant to the lender."

The second war front appears to be going on with currencies.  There seems to be a determined effort by many of the world's governments to debase their currencies.  Those that attempt to weaken their currency think that by doing so they will increase their country's competitiveness in the world marketplace. They think that be debasing their currency that they will boost exports, create jobs and boost company profits.

However, like most things that government does, such a strategy is extremely short-sighted. It may provide a temporary benefit but it rarely will benefit the country over the long-term.

I had the good fortune to spend a day with Arthur Laffer 30 years ago. Laffer was the economist who was known for the "Laffer Curve" and was considered by many to be the intellectual force behind Reagonomics in the 1980's.  In the period between 1980-1985 the U.S. dollar was very strong relative to other currencies and there were many who decried its advance and argued that government policies should be taken to weaken it.  I remember Laffer telling me, "Why would anyone want to be weaker rather than stronger?  A strong dollar provides enormous benefits to Americans.  You can buy more.  You can travel more cheaply.  You have greater incentives for productivity and innovation."  I have always remembered that thinking whenever I hear about the "advantages" of weakening our currency.

Axel Merk of Merk Investments reminded me of my conversation with Laffer in a recent article he wrote entitled "Currency Wars Are Evil".   Merk does not mince any words right at the top of the article.

Real people may die when countries engage in “currency wars.” Countries debasing their currencies risk, amongst others:
  • Loss of competitiveness
  • Social unrest
  • War

A few of Merk's comments on each of these points.

Loss of Competitiveness
Importantly, when a country subsidizes one’s exports with an artificially weak currency, businesses lack an incentive to innovate. Japan is the best example: Japan’s problem is not that of a strong currency, but a lack of innovation. By weakening the yen, companies are given a free ride, taking an incentive away to engage in reform. Advanced economies, in our humble opinion, cannot compete on price, but must compete on value. European companies have long learned this, as there are rather few low-end consumer goods being exported from Germany. The Chinese have also heeded this lesson, allowing low-end industries to fail and relocate to Vietnam or other lower cost countries: China is rapidly moving up the value chain in goods and services produced. Incidentally, Vietnam has repeatedly engaged in currency devaluation, as the country mostly competes on price; in the absence of a strong consumer recovery in the U.S., we see further currency debasements in Vietnam.

In summary, market pressure to innovate is the most powerful motivation. Governments subsidizing ailing industries through currency debasement do long-term harm to their economies.

Social Unrest 
Currency debasement is not just bad for the corporate world: it’s particularly painful for citizens. Just ask citizens of Venezuela where the government just announced a 32 percent devaluation in the bolĂ­var’s official exchange rate to the dollar. An overnight move of that magnitude is immediately noticeable, as are the negative effects on consumers, whereas gradual debasement in currencies of advanced economies are less noticeable, but ultimately have the same effect. The natural consequence of currency debasement is inflation, i.e., loss of real purchasing power; the two forces meet at the gas pump: as a currency loses value, commodities – all else equal – become pricier when valued in that currency.
Stagnant real wages in the U.S. over the past decade may in large part be attributed to the gradual debasement of the greenback, courtesy of fiscal and monetary policy. Folks whose real wages didn’t go anywhere for a decade feel cheated and are more likely to vote for populist politicians promising change. Currency debasement fosters growing income and wealth inequality and diverging political reactions, e.g., the Tea Party movement on the political right and the Occupy WallStreet movement on the political left. The rise of populism can be seen in the rise of Twitter: we sometimes quip that politicians that can distill their political message into a tweet have a better chance of being elected these days. Except that we are wrong: it’s not a joke.
In the Middle East, similar trends cause revolutions. People can be suppressed for a long time, but if they can’t feed themselves, they revolt. In the U.S., we are told food and energy are to be excluded from measuring inflation, as our economy is less and less dependent on food and energy (although curious that a record number of Americans used food stamps last year). However, in countries where large segments of the population cannot earn enough to feed themselves, currency debasement contributes to revolutions, not just the rise of populism.
When told by Fed Chairman Bernanke that the gold standard prolonged the Great Depression, many feel as if monetary activism were a blessing rather than a curse. In our assessment, Ivory Tower economists are particularly apt at confusing cause and effect. The root causes of a depression are excessive debt, not currencies that are too strong. Currency debasement and expansionary monetary policies are attempts to socialize such debt, bailing out those that have taken on irresponsible debt burdens. But because governments tend to be in the group of those taking on excessive debt burdens, we are made to believe that such policy is for the greater good.
We respectfully disagree: currency wars destroy wealth. Currency wars have a disproportionate impact on the poor, as they don’t hold assets whose value is inflated in nominal terms and that could buffer some of the fallout. Central banks don’t cause real wars. But monetary policy has a profound impact on the social fabric. Abstract theories about how aggressive monetary action are the remedy to depressions ignores the heavy social toll currency wars have on people. For those that argue that the social toll of a depression is greater, we respond that the best short-term policy to address economic ills is a good long-term policy. We cannot see how currency wars can be good long-term policy.
We often hear from "noted" economists like Paul Krugman that debt does not matter.  I have not won a Nobel Prize in Economics like Krugman or a Nobel Prize in Peace like Obama.  However, what I know about economics tells me that debt does matter.  It has to be repaid at some point.  And compound interest is a killer in the interim.  If it is not paid, it still carries a cost-to the borrower who bears the loss of default. A price will be paid by someone.

I also know something about peace.  And there will be no peace of mind for anyone if there are currency and cyber wars going on around us.  Perhaps President Obama can really do something to earn a Nobel Peace Prize the next time by getting our economic house in order.  How about starting by seeing if he can find somewhere to shave a few dollars off of our budget deficit without it being considered a national calamity?  And doing it without raising taxes! And reaching across the aisle and working with Republicans!  I think that just might earn him another trip to Oslo.

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