An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
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Thursday, February 9, 2012
Productivity and Exchange Rates
Let's assume we have a nation "A" with a policy of free floating ("FF") and non-convertible state currency; and likewise we have a nation "B" with the same currency policy.
In A the private economy solely consists of one factory that makes devices called apads, and in B it is the same again, the private economy solely consists of one factory that also makes apads. Both of these factories operate on the quota principle where the workers are required to work 8 hours a day and assemble 8 apads during this time, if you don't make 8 they call in Donald Trump and a NBC moron reality show camera crew and.... you guessed it: "You're fired!!". Each worker receives 1 unit of the state currency for each day they work and assemble the 8 apads. Let's assume this 1 currency unit (labor costs) are the only input cost to either process in both countries.
Productivity is a measure of the efficiency of production. Productivity is a ratio of production (output) to what is required to produce it (inputs). In our fictitious 2 nations, input is the cost of labor which is 1 currency unit per day per employee, and the output in real terms is 8 apads per day per employee.
There is trade in apads between each country and it is settled in the local currency.
Nation A has very well educated and skilled workers who are always "innovating" while they work, they take pride in their work and feel exceptionally blessed to be productive citizens of nation A. One day one of the apad assemblers in nation A comes up with some new "innovation" that enables all the workers to now produce 9 apads per day in the same 8 hours, and everyone is very proud and happy as as this represents a 12.5% productivity improvement!!! Now they can show nation B who is better and more productive!
Unbeknown to those in nation A, while all of their "innovating" was going on, the authorities in nation B become enamored with the currency of nation A for seemingly irrational reasons, and become zealous to obtain it, they have dreams at night about controlling huge balances of the nation A currency. They walk in to the apad factory in the morning and demand that the workers now produce 12 apads per day, even if it takes them 12 hours to produce them and they will only be paid the same 1 currency unit of nation B currency and if they don't comply: cue The Donald. The authorities in nation B think: "Now we can show nation A who is better and more productive AND we will be able to sell more apads to nation A to obtain larger balances of that wonderful nation A currency we have been dreaming about !"
What now happens to the exchange rate of the nation A currency to the nation B currency?
(Hint?: If you work in nation A, the moment your policy makers decided to go with "FF" you got "effed".)
What if Nation A ( USA ) goes back to the gold standard thus pulling Nations B ( EU ) back to the gold standard ?
ReplyDeleteIt makes it easier for the UN to do the same thing and the effect is that everyone is on same currency and loses their sovereignty.
ron paul is not significant
The fact that nation A is FF currency is of no consequence. The issue is that you’ve implied that nation B is no longer actually floating its currency since its hording the currency of nation A. Additionally workers in nation A are only f’ed if the government in nation A doesn’t counter the policy of nation B.
ReplyDeleteIf nation A is a monopoly issuer of a FF fully sovereign fiat currency it could KEEP paying its workers 8 units and cut their hours of work and production. It’s the workers in nation B whom get f’ed. So long as nation B keeps hording the currency of nation A, FF or not the currency value shouldn’t change and nation A gets to absorb nation B’s output while Nation A workers still get paid 8 units per day even though they no longer need to work 8 hours a day.
Seems to me that the leaders of Nation B have intentionally subjugated their workers to the consumers of Nation A. This is an immense benefit to Nation A as it can exploit Nation B's obsession with hoarding its currency (which if can freely create). Let the workers of Nation A relax and take advantage of toiling of Nation B.
ReplyDeleteAPAD Co. wants all their profit to show up in country B where there aren't capital controls. They overstate the cost (inputs) and understate (output) revenue in country A and understate costs and overstate revenue in Country B. The economists in country B gloat about how incredibly productive their citizens are and how lifestyles have improved and thumb their noses at the unsophisticated peons toiling in country A. They chastise the lazy people in country B that didn't get retrained into being APAD designers. Then one day country B removes the capital controls and lowers tax rates and all the revenue appears to occur in country B instead of country A.
ReplyDelete"Unbeknown to those in nation A, while all of their "innovating" was going on, the authorities in nation B become enamored with the currency of nation A for seemingly irrational reasons, and become zealous to obtain it, they have dreams at night about controlling huge balances of the nation A currency."
ReplyDeleteHas the spirit of Nick Rowe possessed this blog, too? ;)
All comments here are further thought provoking... thanks all...
ReplyDeleteMin, I'm not following exactly the many discussions with Nick Rowe at his WCI.
To withdraw from the fictitious, what does Rowe see as the reason for foreign countries to keep insatiably amassing ever increasing USD balances even though they do not have any USD liabilities? Does he view this activity as irrational at some level also? Resp,
dave, I think certain of TPTB in nation A are yes somewhat responsible for perhaps not encouraging B's behavior, but at least not putting a stop to it... Resp,
ReplyDeleteBroll,
ReplyDeleteExports cost, imports benefit yes per MMT. Resp,
TB,
ReplyDeleteNow you are ready to become a CEO of a multinational! ;)
Goog,
ReplyDeleteRon Paul: "Don't mess with Texas!"
Adam,
ReplyDelete"The fact that nation A is FF currency is of no consequence. The issue is that you’ve implied that nation B is no longer actually floating its currency since its hording the currency of nation A. "
What I am considering is that logically, when a nation decides to go FF, it is in fact agreeing to or ratifying the row to let external imbalances occur in it's currency or else why would it float?
And I am positing that if productivity stayed static in or balanced between each nation, it would seem to me that the exchange rate would remain basically constant and you could forget about the need for FF.
The moment you go FF you are agreeing to have a chaos system. This is where nations cross a line imo, right when they go FF. An FF policy is a surrender of govt authority.
FF seems to F everybody except a select few who are seemingly able to profit from the volatility...
Resp,
Matt,
ReplyDelete"... it is in fact agreeing to or ratifying the row to let external imbalances occur in it's currency or else why would it float? "
It allows it's currency to float to provide more domestic policy space should an imbalance occur.
In your example, if nation B did not horde the currency of nation A the FF currency would correct the imbalance in short order. However in your example nation B perpetuates the imbalance by hording the currency. If nation A does nothing its workers end up poor and unemployed. However the FF currency allows nation A (assuming it is also a fully sovereign fiat currency issuer) to extend its domestic policy to ensure that it maintains full employment regardless of the hording of nation B.
If nation A had a fixed or pegged currency exchange rate it is unlikely that it could maintain both the currency peg AND full employment while nation B horded its currency and trade surplus. This is why Brenton Woods eventually failed. The US could not sustain a $35 gold conversion, US dollar exports, and full employment. There was insufficient policy space to meet all of those goals under the fixed exchange regime.
" The moment you go FF you are agreeing to have a chaos system. This is where nations cross a line imo, right when they go FF. An FF policy is a surrender of govt authority."
Actually its the other way around. In order to maintain a non-FF currency regime the government gives up domestic policy space. In the 1960's under Brenton Woods the US was put in a tough position. Gold was selling for $40 an oz in Europe and the US was converting for $35 an oz. For the US to sustain Brenton Woods it would have had to have adopted domestic policies to bring the foreign US dollar purchasing power of gold down to $35 from the $40 it was trading at. This would have required the US to drastically raise interest rates to attract dollars and gold into the US. This would have also caused a major US recession.
A FF currency does not cause chaos overall, it just moves the pain of rectifying the imbalance from being a domestic issue to a currency exchange issue. As with Brenton Woods, under the gold standard anytime a nation found itself in a situation with a drain on gold from an imbalance it would have to enact domestic policies which would cause a recession or depression to protect the exchange rate. A FF currency allows you to maintain domestic policies that would be impossible to sustain under other currency exchange regimes.
Adam,
ReplyDeleteWhat about requiring the Mercantilists to settle in real goods in real time? Would that not make a difference?
Keep the state currency for exclusive use to 1. provision the government sector, and 2. use for settlement of domestic transactions only, 3. domestic savings.
That seems like it would eliminate the possibility of hoarding by the zombie-like, brain dead, moron, greedy, irrational, corrupt, contemptible, external entities; and their characteristically same accomplices in the domestic sector....
Resp,
Matt,
ReplyDeleteLord Keynes' rejected Bretton Woods proposal...
http://www.guardian.co.uk/commentisfree/2008/nov/18/lord-keynes-international-monetary-fund
Adam,
ReplyDeleteOne thing is that I dont think many would like for instance the US surrendering its sovereignty to some sort of international body.
With the tremendous new info technology we have today, it would seem to me that we could require I/E deals to be offset in real terms before we let any product off the ships. We can keep track of all real export product in real time today with RFID/Scanning/GPS, etc.. Just tell the mercantilists/neo-mercantilists that they have to identify the real export product that they are using to exchange for the import product: No real product identified, the ship doesnt off-load; and the ship owner starts to charge fees if the ship cant off-load for lack of ID of real trade offset.
With our latest real time info tech. we can do away with the need to use currency balances as an intermediary in the accounting for I/E like we have had to do for centuries. We could look at this as before we had no choice.
But now we have progressed to the point where we can match up real product in real time for I/E so why use the monetary/banking system any more? We have IT that makes the need for I/E banking unnecessary, why not use it.
Take Customs back out of the DHS (where it doesnt belong anyway) and put it back into Treasury Dept and they could set the system up, probably would provide better security to boot..
Resp,
I'm just wonder that would happen if Nation A went to a dual exchange rate regime ala Ravi Batra's suggested framework?
ReplyDeleteExchange rate issues give me a head ache. I understand the basic monetary balances issue but trade policies have real economics effects which can't captured by the balance sheet approach.
It seems that in principle FF could work but like Bill Mitchell says you would need a lot of capital controls and straight up bans on certain kinds of speculation.
So FF versus Dual Exchange Rates?
I like this thread -
ReplyDeletehoarding U$D treasuries
sovereign fiat currencies
austerity
gold standard
multinational corps not repatrioting Euro earnings ...
and more in one place
Septeus,
ReplyDeleteIve been reading a bit about Mercantilism and Neo-Mercantilism lately trying to understand better where all this zealousness for "trade" comes from which I am evaluating as perhaps a foundational operation that by definition leads to imbalances and directly leads to unjust outcomes...
When I look at mercantilism, the surplus nation's workers get "effed" because they in effect are exporting the fruits of their efforts, and the corrupt authorities in the surplus nation accrue the balances.
But then it is no better under neo-mercantilism as then the deficit nation's workers get "effed" when they get thrown out of their jobs... and then the corrupt authorities in the surplus nation ends up again with the accrual of the balances... so this is a "trap" where to those out of the realm of authority, it's a "heads I win, tails you lose" deal.
This is interesting what you say here: "which can't captured by the balance sheet approach" thats interesting. It is a "form over substance" type of operation where the focus of the authorities becomes the "balance sheet" rather than the real outcomes... this is irrational, zombie-like behavior on the part of the authorities under either the mercantilist or neo-mercantilist approach.
So the common denominator may be mercantilism, which by definition is further facilitated today imo by the implementation of FF policy in the overall policies of our state currency systems.
If you can quickly post perhaps what Bill M has writtten on FF that would be helpful here otherwise I will try to hack thru a search of his blog....
Resp,
The underlying problem is that some people work to make REAL things while others accrue MONETARY things. The surplus nation workers are screwed because they work to make real things while their elite horde monetary wealth. The deficit nations reap the real world wealth at a cheap price, but typically get screwed because their elite take advantage of the nominal wage gap and reduce their wages, again, reaping monetary wealth. Workers get screwed on both sides.
ReplyDeleteAdam,
ReplyDeleteAnd I am considering, as far as a policy of how a nation can set up their monetary system, that going FF is a contributing factor, or helps to facilitate mercantilism.
Not that I think this has any chance of happening, but it is an interesting mental exercise to think of a global system where all trade had to clear in real terms, and perhaps never before in human history have humans had the IT available to them to make this happen...
Up to this point, we've had to use a system of bank liabilities (paper entries) as an intermediatory step... leading to problems.
Resp,
If trade had to be resolved in real goods in real time... wouldn't that just be barter?
ReplyDeleteGee,
ReplyDeleteGood point, but they do call it "trade". ???
Yet intermediate liabilities are involved.. so if you think about it it really isnt "trade".
In my brainstorm here, state currency would still be involved for the domestic economy.
Look without our IT of today, how did merchants know that their goods would be purchased when they got to their destination?
They couldnt "send a cable" or "wireless" or do any pre-coordination at all... did they just load up and take off "on spec"? I doubt entirely. So in this regard it probably was never "free trade"..
Seems that they would have had to have had the assurance or a good idea that an intermediary (broker) would at least take down the cargo when they got there.
Or the entire import/export industry was vertically owned and they had standing orders...
This stinks.
Resp,
(Hint?: If you work in nation A, the moment your policy makers decided to go with "FF" you got "effed".)
ReplyDeleteAbsolutely not, Matt! Depends on which FF you mean. :-) Yes, Free-Floating & nation A doing nothing while nation B hoards A's currency is bad. Huge foreign saving, huge demand leakage, huge unemployment in A.
Well, what comes to the rescue? "A little bit of clear thinking", courtesy of Abba Lerner. As Adam1 & Broll et al point out above.
Another FF. Functional Finance. If B saves X dollars, then Nation A should just print X dollars, give them to the newly unemployed workers or whoever is hurt by B's hoarding, re-employ them, use the JG, etc and use what's left as best it can think of. A very important point is that this is in NO way, shape, or form "cheating" nation B, or diluting B's A-denominated financial wealth.
No unemployment, more real wealth for A, and as long as Nation A spends the newly printed dollars on something reasonably sensible, and the goods that are imported, the apads, are reasonably useful (argument doesn't work if A's people are importing destructive drugs or vials of smallpox) - then A is almost certainly going to be the winner.
The upshot, if they use non-innumerate, functional finance, MMT economics, is that B is using a probably stupid method of attaining full employment, while A is getting a great deal. The A + B system would very probably be better off if there were balanced trade. A's ultimate gain from the trade deficit is probably less than B's loss of real wealth. But both are much much much much much MUCH better off than if either had idiotically allowed their economies to have unemployment. At present, the US is behaving much worse, much stupider, much more oppressively to its workers than China is.
The only caveat I would make, following Bill Mitchell, is that B - China should follow minimum human rights labor standards. A could use tarriff and trade policies to enforce this by making it so there is no incentive for violating them. Slap a tarriff or prohibit importation of true slave-labor products. But if A didn't give a damn, it would not be directly hurt by slavery in B if A ran its own economy sanely.
Lerner covers all this, he calls it a "hostile gift" from B to A, and very simply and beautifully and decisively refutes all of e.g. Ramanan's points, insofar as Ramanan makes ones that I find at all intelligible, in books he wrote many decades ago, that Rowe, apparently another critic, says he read.
Calg,
ReplyDeleteRight I see your point, but consider that if you are (stepping out of my hypo) an Industrial Engineer working in manufacturing and making a decent living.
Then your industry is targeted by the neo-mercantilists, and you are thrown out of your job that you were trained for (and have student loans against) and is creative and fulfilling, for an $8.00/hr job in cleanup or something, you may not consider that a "great deal" for yourself.
Consider that Lerner's FF along with a "Free Floating" state currency policy would combine to enable the rent seekers who operate in a Neo/Mercantilist system.
Granted Lerner's FF would be A LOT better than what our morons in charge are delivering now, dont get me wrong.
Here's another thing, if we took the approach that this neo-merc is a "good thing", and "imports are a benefit, exports a cost" and politely told the Chinese that what they were really doing is sending us real goods and we were just putting numbers in a spreadsheet for them in real terms, all we owed them is a bank account, implying that they were in fact zombie-morons and acting as our slaves, etc.; how long before the ChiComms would change their policy?
Then what do we do?
Resp,