Global rebalancing and the euro

This column was not written with an Irish audience in mind, but given its trade patterns and openness Ireland is obviously one of the countries that is most exposed to the risks it discusses.

13 replies on “Global rebalancing and the euro”

Very interesting – it seems that some large manufacturing firms are already planning for this – Mercedes let it be known during the week that they are considering moving the production of the new C-Class to the US, because production costs are lower there than in Germany and since exchange rates are moving against them in key markets (US, Asia, South Africa). The consequences are obvious.

Even worse, Edgar, these decisions are easier done than undone, as per the extensive 1980s liiterature on hysteresis and exchange rates.

That is what I meant with the obvious consequences (I should have been more explicit).

While I would generally be cautious in talking about hysteresis effect from exchange rate shocks because the shocks are usually relatively short lived (the evidence on long-run impacts of a sterling shock on Irish exports to the UK suggests there are none) we are now looking at a far more fundamental and permanent impact.

Of course one might not just see protectionism in the classic sense increase, but also other distortions such as subsidies to keep e.g. the Mercedes jobs in Germany – also with very interesting consequences.

You might also arrive a situation where one country without the option of devaluing the currency adopts a scheme for competitive deflation via wage cuts and economic contraction. This could in turn spur a wave competitive disinflation elsewhere, with countries attempting to rebalance their external accounts via lower imports. And achieving it, with a renewed slump in world trade for all.

There is another way to look at the narrative, rather than through the lense of the economics point of view.

I encourage those of you interested in global ‘trade’ to have a listen to this Lean Blog podcast from December 2006. Jim Womack is author of a book called ‘The Machine that Changed the World’. He has a Phd in political science from MIT. But Womack became interested in car manufacture and in particular in Toyota. Womack makes some quite basic observations of Chinese industry in this very useful podcast.

My favourite comment from the podcast is, in China the factory represented a ‘control mechanism’. The factory was not only a place of work. It was the school, the home, the hospital. The fact they managed to produce a few tractors now and again was more like a side issue.

I agree with your analysis. The articles you have written on global trade this year have been very informative.
I wonder whether the issue is purely a renmibi issue, or whether it is more an Asian currency bloc issue. I think the latter, the relative contribution to which of indiviual countries is best measured by their trade weights. In that context there appears to be some good news in that there has been a sharp appreciation of one of the largest trade weighted currencies ie the yen.

On your other point, when the financial crisis first broke in August 2007 the ECB and other European central banks, especially the Bank of England, paid insufficient attention to the build up of large and serious tensions in the financial system, (in the global interbank-market and the large shadow banking system) which closed down, from an early stage, the inter-institutional and cross-border liquidity provision markets, leading ultimately to the greatest ever financial crisis, which in turn had an enormous impact on the global economy.
This position persisted until Oct 08, after the collapse of Lehmans and only began to be rectified then.
I think part of the reason for this was an overly German-centic perspective taken by the ECB, due to the heavy intellectual influence of the Bundesbank on it’s deliberations, built-in as part of the political compromise leading to the establishment of the ECB. Given that, since unification, Germany has been on a different economic cycle to much of the rest of Europe, this influence has had an unfortunate pro-cyclical impact on major parts of the European economy which has turned out to have been enormously damaging to many countries, including Ireland. In my view, it also led to an over concentration on the danger of second round inflation impacts arising from the commodity driven inflation which coincided with the first year of the financial crisis. These second-round effects did not, and were never likely to, materialise given the much more flexible labour markets which exist in most contries, although, perhaps not Germany?, compared with the 70’s and 80’s.
The damage done by the crisis to the global financial system infrastructure has not been nearly repaired. Conditions remain extremely fragile, not helped by the continuing instability in the affairs of individual institutions being created by the European Competition directorate, among others.
Many comentators appear to regard large financial institutions as some form of mechanically engineered plants whose output can be calibrated at will.
Of course that is not the case. Large financial institutions are enormously complex human organisms, which are simultaneously grappling with large credit quality issues (much of which has been brought about by the depth and synchronised nature of the recession), historic financial market volatity, management instability and large scale forced corporate restructuring. And the authorities wonder why there in a credit shortage? In making this point I am not referring particularly to Ireland, which is a special case.
The rebalancing of the global and European financial system to a new sustainable equilibrium will take a further number of years. For this reason and because of the argument you make, the ECB needs to proceed very cautiously indeed.

There is another interesting possiblity particularly for small heavily indebted countries – if the dollar is going to depreciate seriously it is wise to have all the debt denominated in dollars. Obviously that won’t work if everyone does it – I must have a look at the Obstfeld-Rogoff paper to see wether they factored this in.

Couple of comments: The Chinese are a law unto themselves. They are even more xenophobic than the US. Don’t expect any assistance from that quarter.

Over the last three decades there has been a massive increase in the world labour supply with respect to internationally traded manufactured goods. In effect, the entire industrial labour forces of the US and EU combined, have come on-stream in east Asia with devastating consequences for the former two regions (more labour supply = lower wages). This process will tend toward equilibrium unless forced backward.

The US and other western economies reacted to the increasing east Asia labour supply by transferring many major manufacturing enterprises eastward. Talk about cutting you own throat!

Anyhow, to compensate for the loss of the manufacturing, they built an alternate economy using credit and dept as the input and output. This is essentially a Ponzi scheme and will collapse (credit is virtual, but debt is real) It has not yet collapsed, but is in the process. Its like watching a slow-motion boxing contest. Surreal!

You might well ask whether or not world-trade flows are a proxy for economic activity. Probably are, but its the overall direction of the flows that are crucial. And what is in those ship’s holds and stacked containers – raw materials or finished goods? Makes a big difference in terms of nett energy content.

If the western economies are tuckered-out on debt, why would they want more tucker? They won’t – well not for some time anyway. So to whom are the east Asians going to offload their manufactured goods onto? Themselves? I fancy not – except their respective governments dramatically increase the disposable incomes of their populations to convert them into consumers. Then we’re back to the Ponzi credit/debt scenario again! What would you term this type of behaviour?

I think some reality analysis needs to be applied. If you have 100 units of a raw material resource available and you consume 50% of it in 69 years (numbers are only by way of illustration) – that is, your incremental rate of increase use is ___ %: So how long before you consume 50% of the 50%? ____ years. Continue this for a couple of more iterations.

Fill in the blanks yourself. You may not like what you discover. As I said above, some reality checks appear to be in order.

B Peter

@ BP Woods,

All I would add to the above, is we need to be very careful in terms of the use of the word ‘manufacture’. Because there is modern, efficient and clean manufacture as the Japanese endeavoured to perfect and the US etc subsequently tried to learn. Then there is the earlier stage known as mass production manufacture, where you de-skill the workforce and offer life time employment to many people who are not extremely happy with the challenge their work offers them.

Then there is what the Chinese were doing – which was not even mass production never mind getting up to the Lean type system of Dr. Shingo. The Chinese are struggling to come from so far behind that it isn’t even funny. In the podcast I linked above, Womack talks about the workers in China who stand dutifully on the production line all day long, even though no product is coming down the line. Except for the item that passes down every half hour. That wouldn’t work in Europe or the US. Because the workers would all walk away and go for cigarette breaks.

I mean, when I worked at Dell we had the opposite problem. If every worker wasn’t pumping in all six cylinders, the line would start to pile up like the cars on a motorway. I have seen it happen too. Where product literally started to collide off one another and spew onto the floor where it got broken and had to be dumped. That is the way production worked in Limerick city. I don’t mean that product was falling on the floor all of the time and being damaged. But the line capacity was used to such an extent that it was always within five or ten minutes away from backing up like I described.

So my basic message is, be very specific and selective in terms of using the word ‘manufacture’.

As a minor matter of interest, I have noticed in my research recently that many of the lessons learned in the arena of industrial manufacture and being applied and tested within the healthcare field today. That little observation might be interesting to someone here who is working on the issue of cost and productivity in Ireland’s healthcare system. Norman Bodek’s writing and publishing is a great place to start to learn on that score.

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