War, Currency Exchange, and A Framework for Understading Weak Dollar Policy

The Coming World War

Much has been written about the fall of the US Dollar against the Euro, and most of it myopic. I propose a new framework for looking at the currency crash, one that just might surprise you.

In short, Europe and the US are at war. However, in this war no shots are fired…though the outcome may be just as disastrous for the loser, the spoils just as magnificent for the victors. If there is no decisive winner of the economic war, physical warfare is sure to follow.

Sound like conspiracy pablum? Let’s step back a little bit and look at the situation.

Motivation

First we have to understand that there is a theory that accounts for the way nations act, and why they present and act on the policies they do. Policy is not a random reaction to spontaneous events. . .but rather a carefully planned and executed program where by each country advances an agenda that reflects their own national self interest.

The first step in understanding US Dollar policy is to understand this concept of national self interest: countries act in ways that advance their self interest. Once we accept this, we have a useful lens through which we can examine the current state of the US Dollar, Sino-American relations, and recent programs promulgated by the European Union.

A Weak US Dollar, A Strong Euro

We have witnessed in recent history the precipitous fall of the US Dollar against the Euro. Administration officials hardly bat an eye in regards to this, and some even speculate that Bush supports a weak US Dollar policy. If we presume that there is a rational and intelligent reason for this, we must try to figure out what that reason might be? As our premise for analysis, we must assume two things: 1) That the administration is able to exert some level of control over the value of the US Dollar and 2) That American policy reflects US national self interest.

While not absolute, countries are able to exert influence on currency valuations. In the past, US policy has been to support a strong US Dollar. This is obviously changing. The real question is, Is it changing due strictly based on free market evaluation or is there a policy that is informing and in fact, supporting cheap US Dollars? If so, why?

A US Dollar that is weak against the Euro makes it more expensive to travel to Europe, of course. But, beyond that, what are the ramifications? Primarily, European imports become less competitive compared to domestically manufactured products. When the US Dollar is strong against the Euro, American products are less competitive. By having a weak US Dollar, we can export more, and the result is that US manufacturing can compete more readily. Over the long term, a weak US Dollar will help spur a resurgence in US manufacturing (an industry that many analysts lament we have all but lost over the last several decades).

As a result, the ramifications of a weak US Dollar are this: American made products are cheaper to sell abroad, the cost of importing European made products increases (over the long run, this leads to direct investment by foreign companies in manufacturing facilities in the US…kind of like the inverse of what we’ve been seeing happen to American jobs over the last decades). The down side is that the relative cost of raw materials may increase…but fortunately, the US has the ability to produce much of its raw materials internally or from underdeveloped nations that have weaker economies still.

The China Connection

Any discussion of the ramifications of US dollar policy, especially when related to the Euro, is lacking if it does not address China. For the past few years, the Chinese currency, the Yuan, has been artificially tied by the Chinese government to the US Dollar. This has had the effect of stabilizing their currency as their country goes through a revolution in manufacturing and industry. When a country is growing like China is, they need a stable currency to keep their development on track and moving in the right direction. In short, China cannot afford an unstable currency. If the Yuan rises too fast, they can’t export. If it falls too fast, they can’t import or make money.

Because China has pegged the Yuan to the US Dollar, it has enjoyed many years of stable currency exchange, allowing them an artificial buffer against the natural market fluctuations of a new and explosively growing economy. But, China has been grumbling of late about the fall of the US Dollar. Recently, they have suggested that they will float their currency on the free market instead of keeping it tied to the Benjamins. What would the impact of this be?

Well, the Yuan would do an Enron. The moment the Yuan floats, it will skyrocket up. Everyone will want to buy them. But, a rising Yuan like a rising US Dollar will mean that Chinese exports are less competitive and more expensive to buy for import nations. By decoupling the Yuan from the US Dollar, China will be hindering its own ability to provide cheap export goods for the world market.

Once the impact of this comes to light, the Yuan will then crash. Either case is good for the US economy. A high Yuan, like a high Euro, stimulates US manufacturing and exports as our products become comparatively cheaper for these countries to import. A high Yuan means that suddenly it is cost effective for Chinese to buy and import US manufactured goods instead of buying domestically manufactured goods. The result of an outrageously high Yuan would be that once the world recognizes the impact on their export potential, the Chinese Yuan will fall through the floor. Currency traders, those ever fretful sheep of the open market pasture, won’t be able to get rid of the Yuan fast enough. They’ll all try to cash in at the same time, when the Yuan is high…and the end result of so many people getting rid of the Yuan will cause it’s value to fall to the floor. …hence, the Enron scenario.

One alternative recently discussed in the media is the possibility that China will uncouple the Yuan from the US Dollar and immediately couple it to the price of the Euro. However, this is not a safe bet for China…as every day the Euro is becoming more and more valuable…again, making it more and more difficult to compete against goods produced in countries with cheaper currencies.

So, China is faced with an uncomfortable prospect of deciding between three courses of action: 1) Floating their currency on the open market (and watching the Enron scenario unfold) 2) Coupling the Yuan to the Euro and watching their export economy wither. 3) Maintaining the status quo and enjoying the benefits of favorable export economics to European markets.

Plowshares or Swords?

Sadly, the natural state of mankind is not peace. While most people assume that the world has enjoyed a half a century of peace, this is far from the case. The years since WWII have been some of the most bloody and tumultuous times in history.

With the advent of the European Union, we see for the first time the potential of a wholly unified Europe not dreamed of since Hitler. In and of itself, a unified Europe is not necessarily a frightening prospect. However, we cannot simply assume that the EU is harmless and beneficent. In fact, if we step back and look at some of the programs that the EU is promoting, we begin to wonder if they are not building the foundations of a wartime manufacturing infrastructure.

The Airbus initiative is one prime example of this. Here we see large member states of the EU dumping vast amounts of money and subsidies (which is verboten according to free trade policies) into a joint development plan for an airplane manufacturing industry. The ostensible reason is that it creates jobs for European member states. This, of course, cannot be argued. But it is hard to believe that for the same level of investment they could not create more jobs than those created by the Airbus initiative. Why then airplanes?

Well, in short, it is in EU “National” self interest to have in place the capability to manufacture advanced military aircraft. This is something that has been impossible for Europe until the advent of Airbus. In fact, this is essential for Europe if they are preparing for the possibility of military conflict with the United States. Without the ability engage the enemy in the skies, no country can win a large scale modern military conflict. Therefore, it is important for the EU for military reasons to have a sustainable aircraft industry completely within their member states…only if they see the US (the current supplier and leader of air superiority technology) as a potential adversary or threat.

Wishing Upon the Stars

In addition to large state investments and support of a private aircraft industry, the last few years has revealed one other unusual program that cannot be explained rationally unless one considers the prospect of war with the US. This is, of course, Europe’s insistence on developing and deploying a competitor to the US Global Positioning Satellite System. The European system is called Galileo and for the cost of several billion Euros will provide the world with essentially the same service that is currently available for free through the GPS system. The only rational reason why Europe would need their own GPS is if they need expect that they will not have access to GPS in the future. And the only reason for that would, of course, be war with the US.

Side benefits of deploying Galileo include growing expertise in satellite systems. This is essential when considering a large scale conflict with other modern nation states. Control of space is for tomorrow is what control of the air is today, and the importance of air superiority today is as important as necessity of naval superiority of yesterday. In short, any country that cannot produce platforms for the air is not a contender in today’s battlefield. The same will hold true tomorrow for space based capabilities.

Airbus and Galileo are two readily apparent examples that suggest that the EU is developing the infrastructure necessary to support a war against a modern nation state. While arguments can be made that these are perfectly peaceful and justified programs, we kid ourselves if we do not at least acknowledge that they are very much dual-purpose industries. Today’s airliner is tomorrows military cargo transport.

Back to the Benjamins

If we look at all of this in the context of the relative value of the US Dollar one begins to wonder if we aren’t already at war with Europe… whether 50 years in the future historians will look at the currency fluctuations as the opening salvos of WWIII… Some speculate that what we are seeing actual war…market war…being fought on several fronts at the same time. The US is betting the economy…driving the US Dollar down in a race to see whose economy implodes first: Europe’s or our own. If the European economy collapses before ours does, we can guarantee that the investments in European military manufacturing and industrial capability comes to a stop. Airbus would succeed or fail on its own merits. The Galileo system will never be built. US remains the dominant world hyperpower.

At the same time that the European economy implodes, the Chinese economy explodes then collapses…causing severe harm to their GDP and increasing popular dissent with the regime.

As these scenarios play out, the scope of the disaster is exacerbated by the enormous selling of euros and Yuans in exchange for US Dollars…making the fall of the US Dollar a glider descent by comparison to what those two currencies will experience.

Review

To review, we cannot look at currency fluctuations in a vacuum. They are related to other programs undertaken by nation states to support their national self interest. If we look at US dollar valuation as related to US self interest, we begin to understand that a weak US Dollar will help to crush the EU while severely destabilizing the Yuan.