2010-07-05

Krugman's Opium War

Antal E. Fekete targets Krugman and those pressing China to revalue its currency.
Friedman asserted, wrongly, that variable foreign exchange rates would eliminate trade imbalances. As the currency of the surplus country appreciates, exports are discouraged while imports are encouraged. Conversely, as the currency of the deficit country depreciates, exports are encouraged while imports are discouraged. This forces adjustments in the volume of imports and exports that will continue until trade balance is restored.

The equilibrating effect of exchange rates on imports and exports is, at best, ephemeral. It may last as long as the inventory of ingredients that go into the exports of the deficit country does. But no sooner had these inventories been exhausted and needed replenishing than euphoria came to an abrupt end. As a direct consequence of the lower value of the currency of the deficit country, its terms of trade deteriorates, while that of the surplus country improves. In particular, the deficit country has the disadvantage of paying higher, while the surplus country has the advantage of paying lower prices for the imported components that go into their respective exports. The competitiveness of the deficit country suffers a further setback. Rather than working towards equilibrium, the floating exchange rate regime works towards perpetuating imbalances, nay, making them progressively worse. It throws the deficit countries into a vicious downward spiral from which it is ever more difficult to escape.
KRUGMAN’S OPIUM WAR ON CHINA (link goes to pdf)

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