Tuesday, October 05, 2010

Going down?

And while stock prices (and gold, but more on that in a minute) are going up, the value of other things are going down. Inflation has been virtually nonexistent this year. Prices for most retail items have held steady or even fallen. The most publicized price drop, of course, has been real estate, which is what started the cascade of financial dominoes over three years ago. Yet even after all that time prices do not yet seem to have hit bottom, with recent forecasts being for another 10-20% drop still to come.

Recently, however, a more disturbing drop has been occurring and that has been in curency exchange rates. Last year President Obama said the country would export its way out of the recession. The only problem with this strategy is that all the other stumbling developed economies are also trying to export their way to recovery. If everyone is exporting, where are all these products going to? Mars?

The result has been a competition to see who can lower the value of their currency the furthest and the fastest. Since these countries all have more or less the same costs and levels of efficiency, the only way to make their products cheaper, and therefore attractive to foreign buyers, is by making their currencies cheaper. This bizarre competition has been dubbed the “race to the bottom.”

This isn’t just an academic exercise, however—it has real consequences, most of them bad. If pursued long enough it really does mean those dollars we have (or Yen or Euros or Pounds) really do lose value. So how can everyone’s currencies lose value at the same time? Good question. It does sound impossible since we usually thing of a currency’s value relative to other currencies. If they’re all dropping they should actually stay relatively the same.

Yes—and no. Currencies are also valued for what they buy (obviously) and it is possible that they could all start buying less of certain things. Like gold, or oil, or a number of other commodities which have been going up in price recently. The meaning and ultimate value of gold is a topic of endless debate. Its practical uses are pretty small yet its supply is remarkably constant—and also small. Thus, it remains popular as a kind of economic insurance: you can’t do much with it yet it is always in some degree of demand. Many are interpreting gold’s recent fairly dramatic run-up in price as a sign that people are trying to get away from national currencies. In other words, it’s a vote of “No confidence” in the whole global economic system.

Sound complicated? You have no idea—no one does. And this is what makes our current situation so scary. We really are in uncharted waters. Could currency values start tumbling in a free-fall? Perhaps. The central banks have pumped trillions of dollars (or their equivalent) into the world’s economy over the past two years with virtually no result. Where has all that money gone? If that money suddenly started getting pulled out of the corporate mattresses and cookie jars where it’s hiding, inflation could go through the roof. Yet we want them to spend some of it to get the economy moving again—that’s why it’s been given out.

The gaping hole in what I’ve said here is that there has been no mention of the “BRICs”: the developing powerhouse economies of Brazil, India, and of course China. China’s economy is huge but in some ways still very primitive. Yet it has already been making economic waves around the world. How it fits into the rest of this economic puzzle is anyone’s guess. It’s very new at this mega-economics stuff and could make some horrendous mistakes. Or not.

In any case, the simplistic talk of whether we are in a recovery yet or not is so beside the point as to be laughable—laughable except for the fact that we’re talking about the economic well-being of hundreds of millions of people. The only thing that’s certain is that we have a long road ahead of us.


David said...

Sounds like you're making a case for investing again. Not gold (blech) but stocks.

Doug said...

Oh no, David! LOL Read my post right before this one, "Going up?" I think the huge dilemma right now is that there is NO safe place to invest, or even save. Real estate? Equities? Bonds? Gold? I don't think there has been a time in anyone's memory of more uncertainty. Even sticking your money in the proverbial mattress could backfire if inflation returns. The economy has frozen up for very good reasons: no one, including the experts, knows which way to turn. Everyone is being very cautious and "risk" is a 4-letter word.

David said...

Well, gold is a 4 letter word. Did you know you can make it out of lead these days?

Glenn is going to hate me.