New Internationalist

Day six - trading terms

April 1984
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A false balance is an abomination to the Lord:
but a just weight is his. delight.

PROVERBS 11:1

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THE world recession’ is the commonest excuse for economic failure that politicians use these days. And, who knows, in some cases it might even be justifiable.

To see how likely this is we are going to have to look more closely at international trade - at all the exports and the imports and the ‘balance of payments’ crises.

Your typewriter I see has ‘Made in Italy’ on the front. Not very patriotic.

Patriotism doesn’t enter into it. You might say I’m contributing to the growth in international trade - doing my bit as a world citizen. That’s according to the ethos of ‘free trade’ anyway. The theory as if we all specialise in making what we are good at and trade freely then the whole world will grow richer.

You can draw a parallel with what happens in your own home. Suppose you are the better cook and your partner is the better gardener you should both be better off if you do the cooking and he or she does the gardening.

I’m a terrible cook and a lousy gardener.

Maybe. But if your partner is a really superb gardener and only slightly better than you at cooking then it will still pay you if he or she sticks to the gardening. This assumes, of course, that you are permitted to enjoy the garden. If the benefits are not equally shared then the ‘division of labour’ is a much more questionable way of doing things.

International trade involves the same kind of specialisation. The rich countries are now good at making manufactured goods and the poor countries have the raw materials. But in this case, as we saw yesterday, the benefits have not been shared equally.

I’m still a bit unconvinced about this Italian typewriter. Don’t we make them as well?

Yes we do. My choice is purely a matter of taste. And my reasons for preferring a foreign typewriter may be very’ minor. But the problems such preferences cause can be very severe. If it happens too often you get a ‘balance of payments problem as imports greatly exceed exports.

Alarm bells start to ring at this point because there will be a leakage of spending out of the home economy and into the Italian one. This will bring the dreaded multiplier into play - much as it did when money leaked into the banks, as we saw on page 15 - and the entire national income can drop as a result.

But the buying and selling of goods is not the only thing which affects our balance of payments. When we buy the services of people in other countries - staying in their hotels for example - this purchase counts as an ‘invisible’ import. And when we build a factory abroad or place money in a foreign bank account we are diverting capital from our home economy.

Sounds terrible - how can we stop it?

Don’t worry. There is a kind of natural control over such dealings because of the foreign exchange market. To do any business in another country you usually need to buy some of their currency. And it can become discouragingly expensive.

Because of the huge volume of international transactions there are dealers buying and selling currencies the whole time. And the exchange rates between them move on the basis of supply and demand. When Australia, say, wants to buy cars from Japan she must do so with yen. So she must sell Australian dollars to buy yen. When Japan wants to buy grain from Australia she must sell yen and buy dollars. If Australia consistently imports more than she exports, and has a ‘balance of payments deficits there will be an excess of Australian dollars on the foreign exchange markets and this will tend to push the exchange rate down.

But think what happens then if the value of the Australian dollar does fall. This will increase the price of goods imported to Australia - and will make Australia’s exports cheaper and easier to sell. The change in the exchange rate will in itself tend to right the imbalance in trade. So you might think that the whole system would look after itself. Unfortunately it’s not as simple as that.

I didn’t think it would do.

The problem is that the exchange rate can also move up and down in a way which has nothing to do with the balance of payments. This is because there is also speculation in currencies as people buy and sell them according to the way they think the exchange rate will move in the future.

There is always a lot of money floating round the world looking for somewhere to stay. Take the US dollar, for example. For many years the United States had a balance of payments deficit. But the people outside the country chose to hang on to the US dollars they were accumulating because they considered them useful for trading with other countries, as a kind of international money, like gold, or just to hold as reserves. As a result there are now many millions of US dollars moving around the world which never touch American soil - a mass of exiled currency of which the ‘Eurodollars’ are perhaps the most famous.

Are these the same as all these ‘petrodollars’ that the Arabs have got?

They are connected. America buy’s much more from the oil-producing countries than she exports to them. So the Saudis can hold their balance of payments surplus in dollars if they want to. Mind you they can change them so they become ‘petromarks’ or ‘petroyen’ or ‘petropounds’ just as easily. The oil surpluses flow around the world according to where they can get the best return.

How do they choose where to put them?

Well, obviously they want somewhere safe. But they will also look for the places where the banks are paying the highest interest rates. They will be influenced too by whether or not they think a currency is going to get stronger in the future - in which case its value will go up and they can make a profit by selling later.

I can see there is money to be made here. But how do you decide whether a currency is going to go up or down?

You could look at the prospects for the country concerned - to see what its balance of payments was likely’ to be in the future. When Britain discovered North Sea oil it was clear that her imports of oil would not be so high in future and that less pounds would be sold. So the value of the pound sterling increased to reflect this. But if everyone judged that a currency was going to appreciate in value, and decided to buy it, then it almost certainly would do so because demand for it would go up - this becomes a self-fulfilling prophecy.

Reserves as here in the US may be kept as gold or currency.
Photo: Camera Press

So the Arabs are speculating in our currencies?

Everybody is speculating in currencies in one way or another. The multinational corporations who do business in fifty different currencies are moving money around the world as fast as a telephone call. Naturally they do not want to get caught out having any of their assets in the wrong currency at the wrong time.

Apart from the activity of speculators it can often happen that the actions of another government can have a severe effect on your own currency - When the United States decides that it will pursue a monetarist policy it will increase interest rates. This attracts money from everyone and people want to buy dollars so they can put them in American banks. The value of the dollar goes up as a result. Other countries must then raise their own interest rates in retaliation to hang onto the foreign money that has been invested in their own banks. So a monetarist approach can cause problems not just in the USA. The banking system will transmit a tight money policy to other countries too and discourage investment. So recession can pass around the world not just because of a general decline in trade but because of the way interest rates are set in one country.

I still don’t see why it matters if a currency rises or falls.

Well if a country has to import a lot of its raw materials then the price of these will rise as their currency falls and this could trigger off a round of inflation. But at the same time their exports to other countries will be cheaper and this may well increase sales.

A rising exchange rate could be worrying too, however, since this makes your goods sold abroad more expensive and makes imports cheaper.

Seems like swings and roundabouts to me.

It may well be. But the central point is that currencies may move in a way that is damaging yet the country concerned will have relatively little influence over what’s going on.

So what can they do about it?

One thing is to try and influence the foreign exchange markets by having the country’s central bank buy or sell its own currency. So the British government could buy or sell pounds in an effort to stabilise the rate of the pound against the US dollar.

Where would it get the money?

Most governments keep reserves of foreign exchange or gold that they can use in the case of emergency like this. So if there is what they think is unjustified speculation in their currency they can try to neutralise it. If there is a temporary problem with the balance of payments which they think will soon right itself they will also draw on their reserves. If they run out of reserves they will have to borrow if they wish to keep going.

Who from?

It could be from another country. or from the international bank or from the International Monetary Fund - the IMF.

Sounds like you’re about to introduce another villain.

The IMF ought not to be a villain - it should be a neutral financial institution. It was set up after the Second World War with contributions from most of the rich countries as a fund from which countries could draw when they were in temporary difficulties.

If the problems are genuinely and obviously temporary then the loan should come almost automatically. It is when they look more permanent that the arguments start. The IMF will look at the country’s economy and decide what they think the problem is and what they think should be done. Any substantial loan will then be conditional on these steps being taken.

That sounds eminently reasonable.

It depends what the steps are. IME policies may remove balance of payments problems, but often at great social and financial cost - as we shall see tomorrow.

A more direct way to cut imports of course is to raise tariff barriers to make foreign goods more expensive - though this is something that the IMF with its free trade philosophy is very loath to suggest.

This is not just an option for poor countries. If demand in the UK economy were to increase, for example, then there is a distinct possibility that this would be met from an increase in imports from countries like Japan.

The Japanese are causing problems everywhere. They have become so efficient at high technology industries like electronics that they also have manpower spare for relatively less sophisticated industries like steel and car production. The technological revolution is raising serious political issues everywhere because it will mean sharing of work if everyone is to be employed. The Japanese, who are at the forefront of such change, are unwilling to take this difficult step within their own country so they are effectively exporting technological unemployment to other countries.

To extend the cooking and gardening analogy used earlier it is as if your partner had so mechanised the gardening that he or she had time to do the cooking and sweep the yard as well - leaving you with nothing to do at all. If the benefits of all this are equally shared you might enjoy the enforced leisure. If they are not, then the relationship is likely to become strained.

So there could be an argument for freezing the imports of Japanese goods to existing levels to ensure that increased demand locally would generate income and investment locally - and increase productivity in the long term.

But won’t they retaliate if we keep out some of their goods?

Not necessarily. The Japanese have an interest in the economic health of the other countries they trade with, so it could be in their long-term Interest too. In any case there is nothing sacrosanct about free trade. It usually offers more freedom to the powerful and restricts the freedom of the weak. So it should be adopted more as an act of strategy than a permanent tenet of faith.

International trade permits a division of labour that could make the world as a whole richer.

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But the benefits are unequally shared and are taken by the strongest economics.

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Such trading between countries usually results in a surplus or deficit in the balance of payments of each.

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Currency exchange rates move up and down to reflect this, but are also affected by speculation and interest rates.

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Those countries which get into trouble may have to borrow from the International Monetary Fund.

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Or if they see themselves at a more permanent disadvantage they may be tempted to take protectionist measures.

This feature was published in the April 1984 issue of New Internationalist. To read more, buy this issue or subscribe.

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