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The Yin and Yang of economics playing out in currencies and why this is delaying a rise in US interest rates.

Conservation is a universal law of physics. For every action there is an equal and opposite reaction. It also applies to economics. You cannot create something from nothing. If you think you can then you are missing the downside of your actions. In simple terms for every transaction where you make a profit someone else makes a balancing loss so overall it is break even. Sometimes the balancing items are obvious, many times they are not because you undervalue the costs imposed or they make themselves obvious at a later date.

Currently countries are having currency wars by using easing monetary policy i.e. cutting their interest rates to devalue their currency and make their exports worth more and imports more expensive – both give an impetus to their local companies. They export their problems to the rest of the world, one country’s easing monetary policy effectively becomes everyone else’s tightening monetary policy. 

To balance this action other countries are suffering a cut in competiveness so they earn less on exports and their local businesses have trouble competing with imports. This leads the other countries into recession and deflation. The other countries need to take retaliatory action or suffer the consequences. After the dust settles we have no improvement in the competiveness of each economy and interest rates are much lower.

For monetary policy to be effective you need different parts of the global economy to be in different phases of their economic cycle. A country that is going gangbusters needs tightening monetary but may get this indirectly from other countries using easing monetary policy. The globalisation of economies has brought each country’s economic cycle closer into phase and reduced the effectiveness of monetary policy.   

The improvement we have seen in the US economy has been at the cost of other economies doing less well than they would otherwise have done. Now the shoe is on the other foot, the monetary easing that everyone else is doing is effectively monetary tightening for the US pushing up its currency. This delays the need for the US to increase interest rates.   

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