Exporting Inflation

The WealthCycles Staff

For years, Michael Maloney has been talking about the “exorbitant privilege” granted to the U.S. dollar with its role as the premier international reserve currency. Over the years, the United States has abused its role as issuer of the world’s reserve currency—silently stealing wealth from the world through currency creation.

Behind the machinery of the world’s financial systems, dollars are the medium of exchange the world transacts in. So every time the Federal Reserve creates a new dollar, the rest of the dollars in the world get devalued—whether they are in the United States or the United Kingdom.   

The “exorbitant privilege” comes from the United States’ ability to essentially dictate monetary policy to the central banks of the world.

Here’s what we mean: If the Fed engineered a drop in the value of the dollar, foreign central banks would have two choices: a.) allow the dollar to fall and the allow resulting rise in the local currency, or b.) force the local currency to fall alongside the dollar.

If the dollar fell, it would take more dollars to buy other currencies. For example, say today one dollar would buy you 82 yen. If the dollar were to fall tomorrow, then tomorrow one dollar might only buy 80 or 81 yen. Conversely, if the dollar fell, it would take fewer yen to purchase one dollar; therefore, each yen would have a higher value against the dollar.

Option A, a falling dollar, would result in bad things for exporters. If the local currency rose, exporters that depend on the U.S. consumer would see painful rises in the prices of their goods. If the Japanese yen rose, the prices of yen-based goods (think Sony PlayStations, Toyota Tacomas, and Nintendo Wii’s) would rise. Fewer yen-based goods would be sold because of those rising prices. This would bring massive pain to export-dependent countries, which would now be priced out of the markets of the all-powerful U.S. consumer. This scenario is the road less taken.

Option B, forcing the local currency to fall as the dollar fell, would result in inflation of the local currency. Just as the Fed would print currency, the Bank of Japan (hypothetically) would create more currency in an attempt to maintain the former exchange rate. Currency creation equals inflation because the more units of currency there are in existence, the less each unit of currency is worth—in other words, the value of the currency would be less. When the value of currency decreases, prices go up. Inflation of a currency results in price inflation.

What this means is that the U.S. could export inflation to its trading partners. But this “exorbitant privilege” might be coming back to bite the United States, as prices, which central bankers believe are controllable, have begun spiking up in places where the financial powers-that-be don’t want them to—oil, food, Chinese goods and services, and of course—precious metals. And even though credit—the bedrock of our credit-based monetary system—is still disappearing (see chart below from the Fed of San Francisco), the Federal Reserve still believes that inflating its way out of recession and financial crisis is a good idea.

The meaning of true monetary deflation is when the currency supply collapses. Credit—which is the basis of the modern fiat currency system—continues to contract, meaning that the currency supply is collapsing as well. That is why the Fed has an itchy trigger finger for quantitative easing and anything else it can come up with to battle back against that deflation. But inflation will continue to rear its ugly head in the places where they Fed least wants it. Free markets have a funny way of behaving naturally—every single time!

Hit the nail on the head. This phony monetary system can't last forever and when it collapses it's going to be ugly.

Great read. Thanks.

great article.

i think i finally get what you mean- deflation is a contraction in the money supply and inflation is an increase in prices. So you can have deflation and inflation at the same time. but if debt or money is being bled out of the system why is there inflation in commodities?

1. Some countries are contracting while others are expanding. If the sum of all is expanding, demand will push up the price of commodities.

2. Cost of production increases (interest rate, wage rate, etc) so pass it to end user. Cost-push inflation resulted normally resulted from increase of money supply. However the effect may be deferred (manufacturer may absorb the cost increase so as to protect or increase market share until no choice but to pass down the cost to consumer). The delayed effect may show up during the contraction of money supply.

3. Crops failure due to erratic weather and disaster, ie food shortage. This have little or no relation to money supply.

Historically, deflation and inflation have meant falling or growing currency supplies. But the definition has been changed to reference falling or rising prices, which obscures changes in the currency supply. Obviously, they relate to one another, but by changing the definition, the action of central banks is let off the hook in favor of just observing prices.

Think about it—if you have tons of new currency while consumers and businesses are still deleveraging, where would you see inflation/deflation? You would probably see deflation in assets that require loans, like cars, homes, and anything else that is primarily loan-based. Inflation would likely pop in necessities and cash-based industries. We can observe some of this in markets right now.

BRAVO! Why won't anyone say this? Not one in a hundred Americans knows this essential economic fact. BRAVO!

Great explanation. I couldn't have said it much better myself.

Great article. thanks

Your welcome mumstheword. Let us know if you have any suggestions on what you would like to see as new content.

I am seeing credit availability shrink for my business. When I look at the graph, it makes sense.

USD depreciate means that foreign goods are more expensive in US and not good for foreign exporter. However, the price of raw materials drops also in relation to foreign manufacturers if raw materials is imported. One thing that cannot drop is labor cost or raw materials produced locally. Cheaper imports also adds price pressure (deflation) to foreign economy thus causing recession in foreign country.

So US is exporting its recession as well as inflation - double edge sword. "Now either you go into recession or inflate our currency together."