Currency, Newton & The Gardner

by Sanjeev Kulkarni

A Parable:

This anecdote, though wrongly attributed to Newton, is none the less an interesting commentary on current economic thinking. On a cold winter morning, Newton and a friend of his were deep in discussions, when they stumbled upon very warm gardening tools in the garden shade. A few other tools were in the sun. They were both surprised that the tools in the shade were warm and the ones in the sun were cold. Deeply troubled by this anomaly, they got lost in deep discussions trying to unravel the latest physical enigma. They spent hours trying to unravel another scientific law and did not notice the gardener, who much earlier had found some tools too hot in the sun, moved them to the shade and took previously hot but now cool tools out of the shade for his gardening.

This imaginary episode summarizes very well the current economic debate on deficit terrorism, helicopter money, “currency wars”, Euro PIIGS defaults or other wide range of snake oil actions to cure the economic bubonic plague inflicting the world economies and trade.

While the clever and the rather unwise across the globe argue and implement policies which are hard to understand, the six pack Joe in US, the slave ants in China, or the Aam Aadmi (Hindi for “Common Man”) in India are struggling with their daily life.

In the US, job growth continues to be elusive, China struggles to move away from pure export oriented economy, Euro Zone is clueless on how to move forward and India seems to have become an onion republic.

A Hypothetical News Item from somewhere in India

Onion Crisis: A Serious Threat to stability of India

The Indian Government is worried about onion terror from abroad. According to sources, the onion shortage represents the greatest threat to the stability of the country. In a news item which appeared in the venerated Times of India,

“Pakistani authorities stopped onion exports via Wagah on Wednesday, ostensibly to control surging prices in markets across the [Pakistan] country. Exports by sea are still allowed as the invoicing system for maritime consignments is less vulnerable to irregularities, sources said.”

The above paragraph describes real news. We now proceed to the hypothetical.

According to the grapevine, the Indian Government is negotiating with the World Bank to give them loan to grow onions in their poor farmers’ backyards. The World Bank is worried and has rejected the loan. It is worried that if the farmers commit suicide the loans would go bad. It wants the Indian Government to restrain its current account deficit instead.

Moving to the real world again, Kenneth Rogoff, economics professor, Harvard University, feels:

“It is not nearly at the levels of India speaking of which obviously your deficit, government deficit has gone up a lot and, although it has been successfully funded for a long time, it makes it hard for you to take away the financial repression which eventually will be a bottleneck to growth. So the government deficits do need to be dealt with at some point.“

Meanwhile the “Aam Aadmi” has decided not to buy the latest cell phone but to grow onions in the village common land…….

Thus ends our hypothetical news, interlaced with real news citations.

National currency management mirror is nation’s self view :

After the currencies got de-linked from gold standard the hypothetical Economist Newton and his friend are trying to find a new universal currency law. It is indeed fascinating that currency management by nations reflects the self view of their respective ruling class.

Washington DC and the FED have, for a fairly long time, enjoyed their owner’s pride of US dollars as world reserve currency. They, therefore, hold a rather “absurd” and almost “religious” belief that they can dollar print their way to continued world dominance.

Beijing current thinking is that they can bulldoze and export their way to world dominance risking the wrath of their slave ants eating away its “paper dragon” status.

New Delhi and RBI response is typical meek based on its colonial past. It is almost as if they want some colonial masters to take control of Indian currency. Other countries are more bullish on Rupee than the RBI. Iran is ready to trade using the Rupee (and probably China as well) but New Delhi seems to have developed cold feet.

Somewhere along the way leaders have forgotten that currency is basically, at the end of the day, an accounting tool to settle international and domestic trade. And the world has been trading since the dawn of civilization, when no clever fiscal or monetary theories existed; currency is simply a modern tool of convenience.

What is Currency?

Currency is, first and foremost, a medium of exchange and an accounting tool. Its value as store of wealth is secondary if at all. Other measures, such as assets like production capability, knowledge creation, innovation, and equitable employment reflect wealth of a nation more accurately. Savvy investors diversify their portfolios across many wealth assets like commodities, real estate, factories, service operations and other means of wealth creation. Stocks indirectly measure the value of a company to create wealth.

A company’s wealth creation process can take a beating; its technology can become obsolete; or demand for its product or service can vanish. This can happen to nations too, PIIGS being a good example. If a nation prints money without corresponding increase in aggregate wealth creation capability, as seems to be happening to the US $, it will lose its value and produce inflation. Stocks of those companies which continue to create value should rise in dollar terms by a larger amount than inflation.

It seems so simple. Somewhere down the line of history, the learned and clever, as well as the unwise, have lost track of the simple issues.  Lost in the clever fiscal and monetary measures which vary depending on the country where they originate is a simple fact that, at the end of the day, “the underlying REAL driver of the economy is jobs.” End of story.

Acknowledgement: Discussions with John Lounsbury led to the writing of the final section (What is Currency?).

References:

Mythbusting:  Current account deficit edition by Ajay Shah (GEI Analysis)

Victims and Winners of Economic Cycles by Steven Hansen (GEI Opinion)

China’s Young College Grads Toil in ‘Ant Tribes” (GEI News Brief)

Income tax authorities raid traders (GEI News Brief)

Farmer Suicides in India (GEI News Brief)

Experts Say India Economy to Slow in 2011 (GEI News Brief)

Iran and India Oil – Currency Dispute (GEI News Brief)

Currency Trade Between China and India? (GEI News Brief)