Joseph C. Sternberg
Ladies and gentlemen, the position of the dollar is critical.
It has long been clear that exchange rate chaos poses major global risks, although many are reluctant to admit it. The danger comes from the decisive and even stubborn disruptive actions of the big central banks, each of which fights inflation in its own way, but equally ineffectively. The resulting fluctuations in the value of currencies (for clarity, in this case, we will call it the strength of the dollar) inevitably spread throughout the global economy in ways that are difficult to predict.
And here’s what happens. Microsoft and IBM are among the long list of major US companies that are reporting serious problems. This is partly because exchange rates affect dollar-denominated foreign profits. Europeans, whose common currency fell below the dollar a couple of weeks ago, are finding that a deteriorating exchange rate is fueling inflation, especially through energy prices. The same is true in Japan, where the yen has fallen to a record high in many decades against the dollar.
The global economy is developing rapidly. But no less rapidly growing obstacles to this growth, generated by the currency chaos. Long gone are the days when a mechanical link between depreciating the exchange rate and improving export competitiveness, and vice versa, was taken for granted. Rapid fluctuations in exchange rates are now taking place through rampant dollar borrowing (up to $13.4 trillion at last count) or through commercial dollar billing, even if neither side is US. Both mechanisms widen the scope of financial difficulties for ordinary companies when prices fluctuate.
Meanwhile, measures that once provided protection against currency fluctuations are now of little help. After a series of crises in emerging economies in the 1980s and 1990s, the conventional wisdom was that emerging markets should stay away from the dollar by borrowing in national currencies.
That’s what they basically did. The only catch is that their lenders are mostly overseas, and all too often those lenders keep their own records in dollars, a new report from the Bank for International Settlements warns. Significant and unexpected currency fluctuations can confuse the value of dollar portfolios. And this, in turn, can provoke a serious outflow (or inflow) of capital, and for reasons completely independent of the economic and political merits of the country – because foreign investors need to redistribute their investment portfolios.
This is how, in practice, uncontrolled fluctuations in exchange rates threaten financial stability at home and abroad. However, such fluctuations also create a philosophical threat that penetrates to the very core of the world market economy.
Modern economic policy, both monetary and fiscal, is often complained about. The essence of the complaints is that it helps to strengthen the role of the financial sector, when tricks with financial statements and fraud with debts bring huge profits. This financialization of the economy comes at the expense of sustainable investment in innovation and entrepreneurship. Looking at the current chaos with exchange rates, it is very difficult not to see the clear failures of such policies.
Look at these corporate earnings reports. Note that fluctuations in exchange rates are more or less the same for everyone, but their consequences vary greatly from one company to another.
First of all, it is very important where your head office is located, and in what currency you issue reports. If Wall Street is in what looks like a bloody dollar meat grinder, then corporate Germany (as an example) is riding the crest of a depreciating euro. Its foreign exchange bonus for 40 flagship companies from the German Dax index amounted to 30 billion euros. This partly helps cushion the blow from higher domestic energy prices.
It is also important what kind of company you have. A pernicious consequence of the rapid strengthening of the dollar is that companies that engage in entrepreneurial expansion and expand their activities around the world suffer. Meanwhile, American companies operating in the domestic market may place some hope that by lowering raw dollar prices, the strengthening US currency will curb the growth of raw material costs.
It is also important how well your managers are financially savvy. Hedging always helps multinational companies reduce the currency risks associated with the exchange. IBM, for example, distributes risk among 35 currencies. But such tactics work only when the company’s financiers are smart and lucky, and correctly insure risks. In addition, it is impossible to accurately determine the costs on an economy-wide scale, and one has to scatter within tens of billions of dollars when it comes to global trade and investment flows, which are measured in trillions annually.
The great political sin is that this will in no way help improve the lure. So how can a company or individual succeed under such conditions? This is a key question for political economy, and the West’s capitalist response must be through hard and patient work, investment and enterprise. But as the currency crisis shows, the answer is increasingly sounding like this: through a good choice of location, and through the skillful use of complex financial derivatives. But this is not the way to operate in a market economy and provide it with political support.
The flexible exchange regime, which central banks are now making the most of, has been called the driver of the efficient functioning of the global market economy. But instead, such a regime turns into another threat to this economy, both in a practical and philosophical sense.