ADB’s Imprudent Investments in the Philippines

From the ADB

The Asian Development Bank’s (ADB) Board of Directors today approved a $350-million Increasing Competitiveness for Inclusive Growth Program loan to help the Philippines improve its business climate through a mix of policy reforms and programs to promote competitiveness and develop labor skills among out-of-school youth.

“There has been marked improvement in the Philippines’ global competitiveness, but regulation, lack of domestic competition in key sectors, underinvestment in infrastructure and a mismatch of skills in the labor market are keeping the country from realizing its full potential,” said Kunio Senga, Director General of Southeast Asia Department.

To help young people better integrate into the labor market and develop workplace skills, ADB is working closely with the Department of Labor and Employment to design a youth job search program, called MyFirstJob, which will be piloted in 2013. The initial pilot will provide up to 1,600 youth with career counseling services, grants for vocational training, and internships with employers.

MyFirstJob is one of several initiatives that will be used to make the labor market more inclusive. Others include the tourism industry-led skills development program and a new tourism quality assurance and accreditation system that will improve skills and competitiveness in the tourism industry.

(bold highlights mine)

Well ADB seems to be throwing away taxpayers money on some wishful thinking measures that, in reality, treats the symptoms than the disease. These will represent taxpayers (ADB’s contributors) money down the drain, as well as more burden to Philippine taxpayers because of the spendthrift loan program.

First of all, the ADB admits that the problem has been one of "regulation and lack of domestic competition in key sectors". So the answer here is to substantially reduce regulatory and legal impediments as well as taxes and all of other barriers and costs to businesses. But ADB has been silent on the details of their proposed reforms.

Second, ADB sees another problem of “a mismatch of skills” in the domestic labor market.

Plagued by a poor investing climate, this only means that domestic markets has been heavily distorted by political interventions.

This is why many Filipinos would rather seek employment overseas and why commerce have largely been done underground or through the informal or shadow economy.

So how on earth does ADB know of a “skills mismatch”? By mere comparison with other economies?

In a free market environment or in market economies, economic systems emerge out of specialization (law of comparative advantage), so what may be advantageous for country X may not be advantageous for country Y. But specialization through the markets has not been sufficiently addressed, again out of political obstacles.

In essence, matching of skills and jobs is hardly the cause the problem but rather a symptom. Yet without a salutary marketplace, there hardly seems a way establish the domestic comparative advantage from which local labor market should cater to. ADB then seems to be presuming the possession of the right knowledge which it doesn't have.

ADB should instead address reforms based on the liberalization not only of labor markets but of the entire economy.

So what good does the MyFirstJob project do?

With the lack of investments, job searches won’t have any material impact. The answer, instead, is to CREATE JOBS through a business friendly environment. Job searches will become a natural dynamic once the business environment expands. Also, job searches can be accomplished by many private sector internet based platforms.

To add, tourism industry-led skills development program can also be handled by the private sector. Tourist enterprises would want to have employees with the right skills to meet the demand of their consumers for them to profit from.

So the demand of the industry will be reflected on supply as local citizens will conform with changes in the industry and of the economy. If the tourism industry continues to boom, so will the number of people who would want to join the sector by acquiring the skills required. And this will be most likely provided by schools or by enterprises themselves through in housing training or education outsourcing. This does NOT need the government.

However “new tourism quality assurance and accreditation system” only means more bureaucracy, red tape and regulations which ADB sees as a problem. So the ADB the loan proposes to do more of the same thing and expecting different results. Hasn't this been called insanity?

At the end of the day, the money that ADB lends money to the Philippine government accounts for as nothing more than political symbolism, wasted taxpayer resources (which means more tax burden for us) and a wonderful ($350 million) business opportunities for domestic cronies and for the pockets of political officials.

A side comment: Could this be the money used to recently pump up the local stock market?

Philippines as Call Center Capital of the World Has Not Been about Wages

If markets are to function freely, we are likely to see division of labor and competition based competitive advantage as the main force driving economic growth.

One such remarkable evidence has been the booming call center industry of the Philippines which has recently been enthroned as “A New Capital of Call Centers” by the New York Times.

And contra Keynesians, who see economics as operating in a homogenous dynamic, the local boom HAS NOT BEEN about wage LEVELS.

From the New York Times (bold emphasis mine)

Over the last several years, a quiet revolution has been reshaping the call center business: the rise of the Philippines, a former United States colony that has a large population of young people who speak lightly accented English and, unlike many Indians, are steeped in American culture.

More Filipinos — about 400,000 — than Indians now spend their nights talking to mostly American consumers, industry officials said, as companies like AT&T, JPMorgan Chase and Expedia have hired call centers here, or built their own. The jobs have come from the United States, Europe and, to some extent, India as outsourcers followed their clients to the Philippines.

India, where offshore call centers first took off in a big way, fields as many as 350,000 call center agents, according to some industry estimates. The Philippines, which has a population one-tenth as big as India’s, overtook India this year, according to Jojo Uligan, executive director of the Contact Center Association of the Philippines.

The growing preference for the Philippines reflects in part the maturation of the outsourcing business and in part a preference for American English. In the early days, the industry focused simply on finding and setting up shop in countries with large English-speaking populations and low labor costs, which mostly led them to India. But executives say they are now increasingly identifying places best suited for specific tasks. India remains the biggest destination by far for software outsourcing, for instance.

Executives say the growth was not motivated by wage considerations. Filipino call center agents typically earn more than their Indian counterparts ($300 a month, rather than $250, at the entry level), but executives say they are worth the extra cost because American customers find them easier to understand than they do Indian agents, who speak British-style English and use unfamiliar idioms. Indians, for example, might say, “I will revert on the same,” rather than, “I will follow up on that.”…

In addition to language skills, the Philippines has better utility infrastructure than India — so companies spend little on generators and diesel fuel. Also, cities here are safer and have better public transportation, so employers do not have to bus employees to and from work as they do in India.

The Philippine call center boom has been about serving the needs of consumers, where consumers perceive that the Philippine preference for American English has been providing her the comparative edge, and of the more superior utility infrastructure investments made by local companies.

Quoting David Ricardo (Mises Wiki) [bold emphasis mine]

Under a system of perfectly free commerce, each country naturally devotes its capital and labor to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by rewarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labor most effectively and most economically: while by increasing the general mass of productions, it diffuses general benefit, and binds together, by one common tie of interest and intercourse, the universal society of nations throughout the civilized world. It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England.

Video: How Wealth Is Derived From Mutually Beneficial Free Trade

Trade is human action: we do this everyday with the aim at attaining better life and live past self sufficiency which characterized the lives of our primitive ancestors.

Trade today is mostly voluntary, it is done by individuals at the community level or provincial or regional or at the national level. The difference in the trading environment depends on the degree of trade freedom, which are mostly shaped by the governing political policies.

Because trade appears as a mundane activity, its manifold benefits seem as hardly sentiently appreciated by the public. In short, the benefits of trade are frequently underappreciated.

And when trade is framed as an aggregate, i.e. substituted with statistics and accounting figures, trade becomes subject to waffling political talking points, and importantly, loses its human touch. Trade, then, becomes subject to acrimonious disputes, many of which results to perverse laws that curtails trade--and prosperity.

The following video, from LearnLiberty.org, presents Professor Art Carden who discusses the basics of free trade from the perspective of the LAW OF COMPARATIVE ADVANTAGE (also known as the law of comparative costs) and how free trade leads to prosperity.

Comparative advantage deals with achieving efficiency out of relative opportunity costs or according to wikipedia,

In economics, the law of comparative advantage refers to the ability of a party (an individual, a firm, or a country) to produce a particular good or service at a lower opportunity cost than another party. It is the ability to produce a product with the highest relative efficiency given all the other products that could be produced.

iPhone Shows Why Global Imbalances Will Remain

Mercantilists are simply wrong.

The are mistaken in arguing for the "currency valve" policy option to address global ‘imbalances’. That’s because these mercantilists read or interpret trade as operating simplistically in an “aggregate” manner.

Yet as this study based on the iPhone’s business process shows, trade hasn’t been that simple.

Trade has been swiftly evolving in such a way that has deepened the role of specialization (division of labor) and national comparative advantages which has affected how “imbalances” are being shaped.

To add, current statistical aggregates tend to overlook many important data points which have been used for policy analysis. This makes many of these politically sensitive data unreliable.

Illustration from Wall Street Journal Blog

The following conclusion from Yuqing Xing And Neal Detert on their paper “How iPhone Widens the US Trade Deficits with PRC” (all bold emphasis mine)

In this paper, we use the iPhone as a case to show that even high-tech products invented by American companies will not increase US exports, but to the contrary exacerbate US trade deficits.

Unprecedented globalization, well organized global production networks, and low transportation costs all contribute to rational firms such as Apple making business decisions that contributed directly to the US trade deficit reduction.

Global production networks and highly specialized production processes apparently reverse trade patterns: developing countries such as PRC export high-tech goods—like the iPhone—while industrialized countries such as the US import the hightech goods they themselves invented. High-tech products such as iPhones in this context do not help increase the US exports, but instead contribute to trade deficits.

In addition, conventional trade statistics greatly inflate bilateral trade deficits between a country used as export-platform by multinational firms and its destination countries. In the case of iPhone trade, China actually contributed only 3.8% of the United States’ US$1.9 billion trade deficit, the rest was simply a transfer from Japan, Korea, and Taipei,China.

If the US high-tech companies, such as the Apple, are willing to share their profits with low skilled American workers by keeping assembling jobs in the US, it would be more effective in reducing the US trade deficits than targeting the exchange rate policy of PRC.

University of Michigan Professor Mark J. Perry has a nice illustration of the composition or breakdown of revenues of the iPhone per location/geography as shown above.

He also notes that

“only about $6.54 (a little more than than 1%) of the full $600 retail price of an iPhone goes to China and more than 60% goes directly to Apple and other American companies (see chart above), according to a "teardown report" by iSuppli that was featured in a July New York Times article. It also doesn't mean that your purchase of an iPhone contributed very much to the U.S. trade deficit, even though that's what the government trade statistics tell us.”

So despite being assembled or "made in China" most of the profits still accrue to the US.

Bottom line: Globalization equals “imbalances”. That’s because of the fast evolving supply chain platforms or networks which has been determining the trading patterns globally.

Yet interventionist policies based on easy fixes are likely to backfire since they do not address the business and micro realities of trade.

The Evils Of Devaluation

``The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption. This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation's welfare.”-Ludwig von Mises, The Objectives of Currency Devaluation, Human Action, Chapter 31

Policies can be said to be socially beneficial if gains exceed the costs.

By such measure we can say that devaluation, as seen by some as a necessary evil, is nothing but an illusion.

How? Because devaluation:

1. Undermines the role of the US dollar as international currency reserve.

The role of the US dollar as the world’s currency reserve is to provide the medium of exchange function not only for national use but for the global economy. This means that the main channel of providing liquidity for international exchange is to have strong (overvalued) currency that imports more than it exports. By expanding current account deficits, the US finances global transactions mostly invoiced in US dollars.

However once the US dollar reaches a point where deficits would be vented on the currency, the role of the US dollar as the sole international currency reserve may be in danger.

The global central bank holdings of US dollar have reportedly been down to about 62% from over 70% during the past years. Moreover, as discussed in What Global Financial Markets Seem To Be Telling Us, the clamor to replace the US dollar standard has been getting strident.

Last week, a Latin American trade bloc of 9 members, the Bolivarian Alternative for the Americas (ALBA) declared that it would cease using the US dollar for regional commerce next year (Chosun English).

All these means that if the US continues to devalue its dollar, to point of losing its privileges from international seignorage [net revenue derived from issuing currency], or its international currency reserve status, this would translate to diminished access to global finance to fund domestic (trade or fiscal) deficits, reduced access to more goods and services worldwide, and a diluted leverage on the geopolitical sphere.

In short, the cost of devaluation greatly overwhelms the alleged benefits.

2. Overestimates the role of international trade as the share of the US economy.

One of the mainstream reductio ad absurdum is to overemphasize or, on the other hand understate, the role of global trade in the US economy, depending on the bias of the commentator.

For instance, some deflation proponents use 13% of import share to the US economy as rationale to downplay the transmission mechanism of global inflation to the US economy.

Using the data from wikipedia.com, we note that exports account for only 9% ($1.283 2008) of the US economy ($14.441 trillion 2008) while imports account for 15% ($2.115 trillion). The point is international trade accounts only one fourth of the US economy.

Yet common sense tells us that policies that allegedly promote 9% (exports) of the US economy at the expense of 91%, which is deemed by some as being net beneficial to the economy, is deceiving oneself or is consumed by political or economic ideological blindness, or is totally ignorant of the tradeoffs of the cost and benefits from said policies or is extending the intoxicating influence of political propaganda.

3. Creates Systemic Inflation Which Overwhelms Advantages From Currency Depreciation

When governments decide to devalue, it embarks on credit expansion or conduct fiscal spending or other monetary tools or a combination of these policies, in support of special interest groups, as in the case of the US, the banking system (for media, the exporters) for a specific goal (debt repudiation or promotion of exports/tourism).

This in essence would lead to a redirection of investments or a diversion of real resources from other activities.

If the currency depreciates as a result of the government actions but the impact of which does not reflect on domestic prices, then the interest groups supported by such policies or those that engage in foreign currency exchange or trade will likely incur large profits.

However, once prices adjust to manifest the impact of the currency depreciation on imports and to producer and consumer goods, then the short term advantage erodes.

According to Dr. Frank Shostak, ``the so-called improved competitiveness on account of currency depreciation means that the citizens of a country are now getting less real imports for a given amount of real exports. In short, while the country is getting rich in terms of foreign currency, it is getting poor in terms of real wealth, i.e., in terms of the goods and services required for maintaining peoples' life and well-beings. As time goes by however, the effects of loose monetary policy filters through a broad spectrum of prices of goods and services and ultimately undermine exporters profits. In short, a rise in prices puts to an end the illusory attempt to create economic prosperity out of thin air.” (bold emphasis added)

In short, the beneficial impact of devaluation to certain groups will likely be short term and will eventually be offset by inflation.

4. Neglects The Role of Division Of Labor In Terms Of Imports and Exports

Adding to the fallaciously oversimplistic methodology by which mainstream seem to look at the world as operating from a homogeneous form of capital, whose product is produced by a single type of labor and sold as one dimensional product to an indiscriminate market affected by the same degree of price sensitivity, they also seem to think that exports have little correlation to imports, whereby final product sold abroad are all locally designed or processed- raw material sourcing, assembly, manufacturing, packaging, testing and etc...

The mainstream forgets about re-exports or imports of semi assembled products, parts or components that make up another product to be re-exported.

Applied to Asia, global parts and component trades have increasingly made up manufacturing output (see figure 3)

Figure 3: ADB: Emerging Asian Regionalism

To quote the ADB, ``In Integrating Asia, the share of parts and components trade (PCT) in manufacturing trade shot up from 24.3% in 1996 to 29.4% in 2006. That is a remarkable rise, not least since worldwide its share has scarcely increased, edging up from 19.6% to 20.2% over the same period.

``As a share of GDP, PCT is among the highest in the world in the ASEAN (especially in Malaysia, the Philippines, Singapore, and Thailand) and in Taipei,China, perhaps because the relatively small size of their economies makes specializing in small niches of comparative advantage particularly important. Broadly speaking, the success of these economies is based on policies that welcome foreign companies, encourage technological upgrading, and build strong connections with world markets, as well as on their proximity to Asian neighbors following similar strategies. PCT is particularly significant among ASEAN countries: it rose from an average of 35% of manufacturing trade in 1996 to 43% in 2006. The PCT share in the PRC nearly doubled over the same period, from 12.5% to 24.0%, while in India it remained at around 10.0%.” (bold emphasis mine)

In short, in a world where the integration of the global economy has been deepening to reflect on the specialization or division of labor, imports has significantly contributed to manufactured products which are eventually re-exported. Such trade specialization constitutes as the lengthening of the economic structure.

Figure 4: ADB: How A Typical Hard Drive Is Produced

As an example, the ADB shows how Asia’s parts and component trade (PCT) for a hard disk drive, assembled in Thailand, is networked within Asia and partly outside the region. And that’s merely for a hard disk, which also is only a component for a computer set.

So currency prices haven’t been the only factor that shapes production, but importantly trade openness, comparative advantages, division of labor and variability of markets as the ADB points out.

Here, globalization reveals that the division of labor and comparative advantage has been more than just “ideal” or “theoretical”. Instead, these economic forces depict of its pervasiveness in the global economic capital construct. They have even proven to be a more potent force than simply acquiring market share via currency price adjustments.

Talk about a genuine multiplier effect from free trade!

5. Overlooks On The Role of Societal Transition

One of the reasons why many support the government’s devaluation policies has been underpinned by concerns that US manufacturing output as a share of GDP has been declining.

The misimpression is that jobs have been exported out to third world countries.

Again, mainstream myopia which only looks at the surface sees jobs as one dimensional in nature. Their highly mechanistic viewpoint can’t seem to distinguish between low-scale low-value highly-commoditized jobs vis-à-vis high value specialized jobs or can’t seem to comprehend or digest the role of comparative advantage and specialization or division of labor in a world which practices globalization or freer trade.

The US supposedly is the premiere representative of the world’s democratic capitalism which implies that she has once been the world’s freest economy. Yet it is when an economy is economically free or open to trade that the advantages of comparative advantage and specialization can be seen and felt most.

For instance: in the 2008 capital goods accounted for the top US exports, according to US Department of Commerce, International Trade Administration, ``Capital goods represent the largest goods export category (end-use) for the U.S. with $469.5 billion worth of exports in 2008. The U.S. trade surplus in capital goods rose $12.8 billion to reach $15.7 billion in 2008, up from a surplus of $2.9 billion in 2007.”

On the other hand, top imports for 2008 crude oil, passenger cars, medicinal preparation, automotive accessories, other household goods, computer accessories, petroleum products, cotton apparel, telecom and video equipments (world’s richest countries). This means that aside from final consumption goods, the US imports parts and components for assembly or re-exports as well as raw materials.

The other way to look at this is that the US sells goods or services which reflect on its advance “technology age” state (capital goods) while buying input goods for reprocessing or commoditized goods for the end user.

Simply said, if the world has evolved from the agricultural era (agricultural economy) to the industrial era (manufacturing economy), then we are presently in a transition towards the information age or the post industrial society as identified by Alvin Toffler in his Third Wave Theory.

This means that the lengthening or expanding phase of an economy’s capital structure in an information age extrapolates to a bigger share of contribution from information and technology based goods and services relative to the overall economy.

As much as the share of output in agriculture shrank relative to the overall economy during the industrial era, today’s modern economy should see a smaller or declining contribution from the vestiges of the agricultural and the industrial output relative to economy.

Figure 5: Carpe Diem: Manufacturing Output and Productivity at Record Highs

Nevertheless, contrary to mainstream’s fanatical obduracy, US manufacturing in terms of productivity is at a record high (left window).

Moreover, while manufacturing jobs have been on a decline to reflect on productivity gains (right window), it is only during the last year’s recession where a drop of manufacturing output from record highs occurred. Still yet, all these, signify the advancement and not retrenchment of US manufacturing at the present state.

As University of Michigan’s Professor Mark Perry recently observed, ``More and more manufacturing output with fewer and fewer workers should be considered a positive trend for the U.S. economy, not a negative development. We should think of it the same way as the trend in farming over the last 150 years - we're much better off as a country, with a much higher standard of living, with 3% of Americans working on farms compared to 150 years ago when about 65% of Americans toiled on farms. If we can continue to produce more manufacturing output with fewer workers, we'll be better off as a country, not worse off.” (bold highlights mine)

So anyone who expects a return of the conditions of the industrial manufacturing age in today’s post industrial society simply suggest of the curtailment of progress or a throwback in time similar to Argentina in the 1930s or is against human progress.

And to adopt a protectionist economy combined with massive devaluation, which likewise signifies fear of competition, is a sure route towards decadence.

6. Promotes Capital Flight

Mainstream outlook seem to discern people as irresponsive to the incentives provided for by the governing circumstances. They haughtily presume of better intelligence than most of the society. While they could be somewhat correct, in terms of information (and not knowledge), we know that macro thinking is a poor substitute to the knowledge of F.A. Hayek’s “man-on-spot”.

This implies that when major policies which tend to have a momentous impact on society are undertaken, people consequently will respond in accordance to how such policies are transmitted into their respective fields or industries. In other words, in the marketplace a micro outlook is fundamentally superior than a presumptive model based macro analysis.

And devaluation policies would likely have an unintended effect: capital flight!

While there will be some sectors or interest groups that would benefit from a reconfiguration of investment flows, the alternative bet would be for capital to flow out of the country which have been engaged in policy devaluation and flow into assets of foreign currencies which have not or to real assets.

Economist David Malpass, a columnist at Forbes magazine, recently wrote an incisive article articulating how capital flight will subdue any tinge of benefits from devaluation.

Mr. Malpass wrote, ``Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create. This was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, Yeltsin's Russian malaise through 1999 and the rest. No countries have devalued their way into prosperity, while many—Hong Kong, China, Australia today—have used stable money to invite capital and jobs. The more the dollar devalued against the yen in the 1970s and '80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity. China is doing the same now. It watches in chagrin as the U.S. pleads with it to strengthen the yuan, adding productivity fast with the dollars rushing its way in search of currency stability” (bold emphasis mine)

Figure 6: Casey Research: Drumbeats For The US Dollar

Systemic inflation aggravated by capital flight is likely to overwhelm any purported gains from devaluation.

Currently, foreign flows into the US by both private and official sectors appear to be in a swan dive as the interest to own US securities have evaporated (see figure 6).

If capital flight from US residents and foreigners snowball into a tsunami, then the risks of exchange controls could be in the horizon.

This would be different from the recent capital controls imposed by Brazil, which uncannily slapped a 2% tax on foreign capital flows into fixed income and the stock market (Bloomberg). Such unorthodox move was meant to stem the tide of capital inflows where the Brazilian government deems the recent surge of the real and its stock market as indications of a seminal bubble.

Conventionally, capital controls are instituted to curb capital from stampeding out of a national economy or from the region.

Applied to the Asian financial crisis of 1997 which had been largely blamed by the domestic officialdom on speculative hedge funds, Joe Studwell in Asian Godfathers, Money and Power in Hong Kong and Southeast Asia argue that local tycoons were more culpable, ``An enquiry after the crisis found little evidence that hedge funds and other leverage investors played a significant role. There was widespread in the region of massive capital flight orchestrated by local tycoons; but Singaporean and Hong Kong banking secrecy is such that this is impossible to quantify.”

Exchange controls only serve to appropriate the properties of its constituents and of foreigners. By adopting a close door policy in finance and trade, the impact would be to dramatically increase the risk profile of a country. This should translate to a reduction of wealth via a markdown on assets as investors will pay less to own income flows or property or demand higher premium than where there is full convertibility of the currency.

The bottom line is present policies aimed at attenuating the US dollar risks not only capital flight from foreigners but also from local residents.

7. Raises The Risks Of Global Currency War

The perils of using models for prediction would be the assumption that conditions of the past have similar dynamics today. For instance, when Fed Chair Ben Bernanke used the Great Depression as paradigm for measuring the success of devaluation, he probably assumes that the US dollar today can devalue against other currencies without much resistance or would be cordially tolerated by other central bankers.

This would be highly presumptuous.

During the Great Depression, the US managed to devalue because it operated under a gold standard. President Franklin D. Roosevelt’s EO 6102 basically confiscated gold from every Americans in 1933 from which gold’s role as the public’s medium of exchange had been indefinitely suspended.

Since President Richard Nixon closed the Bretton Woods standard in 1971, otherwise known as the Nixon shock, the US dollar has assumed the role of gold as transaction currency for international exchange and as anchor reserve currency for global central banks.

Compared to gold based notes whose rate of issuance would depend on the rate of output from extracting gold from the ground, which is vastly limited due to the high cost and the attendant risks from mining, should the US decide to massively devalue, it could easily facilitate these using the Federal Reserve’s printing press or the technology enhanced digital press. Yet this would impact fundamentally all currencies, given its role as the world’s foreign reserve currency.

To consider according to wikipedia.org, 14 countries are unofficial users of the US dollar or has a dollarized economy. In addition, 23 countries are pegged to the US dollar. If the US dollar continues with its descent in response to the prevailing policy actions, then basically all 37 countries will be importing inflation from the US. Yet, their economies haven’t been afflicted by the same debt woes.

This may lead to a supply shock, where massive waves of money will be chasing after scarce supply of real goods or property.

Moreover, one can’t discount that the other central bankers may not be as cordial or as permissive as Ben Bernanke expects them to be and might attempt to counteract the US devaluation policies by arbitrarily conducting their own currency weakening process.

At the end of the day, if more and more government hops into the devaluation bandwagon then we could countenance a global currency war. And a global currency war risks a horrendous hyperinflation on a worldwide scale.

Ludwig von Mises has admonished us on the possibility of such risks, ``If one looks at devaluation not with the eyes of an apologist of government and union policies, but with the eyes of an economist, one must first of all stress the point that all its alleged blessings are temporary only. Moreover, they depend on the condition that only one country devalues while the other countries abstain from devaluing their own currencies. If the other countries devalue in the same proportion, no changes in foreign trade appear. If they devalue to a greater extent, all these transitory blessings, whatever they may be, favor them exclusively. A general acceptance of the principles of the flexible standard must therefore result in a race between the nations to outbid one another. At the end of this competition is the complete destruction of all nations' monetary systems.” (bold emphasis mine)

Devaluation is a risk endeavor which US policymakers appear likely to undertake (or in my view “gamble on”) in order to neutralize the impact from an unmanageable debt burden plaguing its system.

And this has been cheered upon by their exponents. Yet given the above, it would seem that policymakers and their cheerleaders don’t truly have the necessary understanding or comprehension of the risks involved or has vastly underestimated them.

Devaluation isn’t a necessary evil. Devaluation can take the form of the inflation demon, from which having emerged from the inferno, may wreak more systemic havoc than expected. After all, in the context of history, devaluations have been the seeds to the extinction of currencies. This time may not be different.