Currency Wars_ The Making of the Next Global Crisis - James Rickards [21]
Imagine this dynamic applied not just to Germany but also to France, Italy, Belgium and the other countries using the euro. Imagine the impact not just on automobiles but also French wine, Italian fashion and Belgian chocolates. Think of the impact not just on tangible goods but also intangibles such as computer software and consulting services. Finally, consider that this impact is not limited solely to goods shipped abroad but also affects tourism and travel. A decline in the dollar value of a euro from $1.40 to $1.10 can lower the price of a €100 dinner in Paris from $140 to $110 and make it more affordable for U.S. visitors. Take the impact of a decline in the dollar value of the euro of this magnitude and apply it to all tangible and intangible traded goods and services as well as tourism spread over the entire continent of Europe, and one begins to see the extent to which devaluation can be a powerful engine of growth, job creation and profitability. The lure of currency devaluation in a difficult economic environment can seem irresistible.
However, the problems and unintended consequences of these actions appear almost immediately. To begin with, very few goods are made from start to finish in a single country. In today’s globalized world a particular product may involve U.S. technology, Italian design, Australian raw materials, Chinese assembly, Taiwanese components and Swiss-based global distribution before the product reaches consumers in Brazil. Each part of this supply and innovation chain will earn some portion of the overall profit based on its contribution to the whole. The point is that the exchange rate aspects of global business involve not only the currency of the final sale but also the currencies of all the intermediate inputs and supply chain transactions. A country that cheapens its currency may make final sales look cheaper when viewed from abroad but may hurt itself as more of its cheap currency is needed to purchase various inputs. When a manufacturing country has both large foreign export sales and also large purchases from abroad to obtain raw materials and components to build those exports, its currency may be almost irrelevant to net exports compared to other contributions such as labor costs, low taxes and good infrastructure.
Higher input costs are not the only downside of devaluation. A bigger immediate concern may be competitive, tit-for-tat devaluations. Consider the earlier case of the €30,000 German car whose U.S. dollar price drops from $42,000 to $33,000 when the euro is devalued from $1.40 to $1.10. How confident is the German manufacturer that the euro will stay down at $1.10? The United States may defend its domestic auto sector by cheapening the dollar against the euro, pushing the euro back up from $1.10 to some higher level, even back up to $1.40. The United States can do this by lowering interest rates—making the dollar less attractive to international investors—or printing money to debase the dollar. Finally, the United States can intervene directly in currency markets by selling dollars and buying euros to manipulate the euro back up to the desired level. In short, while devaluing the euro may have some immediate and short-term benefit, that policy can be reversed quickly if a powerful competitor such as the United States decides to engage in its own form of devaluation.
Sometimes these competitive devaluations are inconclusive, with each side gaining a temporary edge but neither side ceding permanent advantage. In such cases, a more blunt instrument may be required to help local manufacturers. That instrument is protectionism, which comes in the form of tariffs, embargoes and other barriers to free trade. Using the automobile example again, the United States could simply impose a $9,000