Business Insider

Peter Crabb: In a currency war, defend the nation with open markets

Congress hasn’t declared war, but some policy makers think we are under attack. Fears of a currency war are rising.

In response to the financial crisis of 2008, the monetary policy of the U.S. Federal Reserve has been one of repeated attempts to increase inflation. Despite a long period of supplying the financial markets with many new dollars, the value of our currency remains strong.

Over just the past three years the dollar has gained 18 percent when measured against the currency of our major trading partners. The dollar has gained 8 percent and 33 percent against the euro and yen, respectively.

Some policy makers in Washington believe other nations are purposely devaluing their currencies to secure a competitive advantage for their export industries. New federal legislation in Congress would allow the government to impose punitive duties on imports from countries showing a pattern of currency manipulation. Similar bills were introduced in Congress in 2011 but never became law.

It’s in times like this that many call for an international, fixed-currency agreement. Calls are rising for a renewed gold standard.

The argument for a gold standard is based on the risk of too much debt. When a country’s money supply depends on its stock of gold, the government is physically constrained from expanding credit too far. In our current system, the Federal Reserve can simply keep buying up bonds, thereby expanding debt with theoretically no limit. A gold standard would supposedly protect us from this risk.

One problem with a gold standard is that you create an incentive for people to spend too much time trying to find more gold. Political problems arise when everyone is searching for more and more gold, diverting valuable resources away from finding investments in new technologies or other productivity enhancing processes, such as education.

A better system is a more competitive world market for both goods and capital. The onset of a currency war may be just what is needed to bring that about.

To control governments’ ability to expand credit, you have to control incentives. Currency competition can do just that.

When a central bank expands credit in its home country, the value of the currency falls relative to others, and the total amount of available credit will fall as capital flows out the country. Even if the lower currency value helps exporters, the gains will be short-lived, as less capital is available for investment.

An open and active foreign exchange market, with its corresponding open and active global trade, controls credit expansion. So rather than fight the foreign currency markets, policy makers should seek even more global trade.

The United States is currently negotiating two new international trade agreements. The Trans-Pacific Partnership would expand trade across the Asia-Pacific region, and the Transatlantic Trade and Investment Partnership would do the same with the European Union.

Economic theory and historical evidence have long shown the benefits of free trade across borders. If we can complete the new trade agreements, the benefits to our economy will override any concerns about currency values. As more markets open up for both exports and imports, foreign exchange rates will balance themselves out.

There is no need to fear a currency war. Open markets are your best defense.