The question of how large the American economy is may seem trivial at first. A simple glance at the most recent GDP statistics should suffice, one would think. However, there are many things that go unreported in this figure, their failure to appear causes many policy errors, and in the unlikely event of a currency dislocation, companies’ exposure to specific markets may have big repercussions on their share of the global market.
There are three different factors influencing GDP and the global market share which go quite unnoticed. One of them, debt in all its form (household, corporate, state), will be left out in this article as the focus here is on exchange-rates and wealth-generating activities.
For years the U.S. government has been trying to lure the value of dollar down in order to increase exports. But that recommendation is missing the rationale of what an undervalued currency is supposed to achieve. The role of the exchange rate in Asian economies is usually misreported. The reason Asian nations manage the value of their currencies is because their emphasis lies on developing an industrial sector and becoming an advanced nation in the first place. It is not really jobs they want, they want the economic attributes of a modern nation – an industrial and manufacturing core. Before they can focus on living standards and consumption, they need to become developed first, and enthusiasm for reform usually runs out after a generation, which is why they need to be quick.
Initially, this strategy serves them well as they attract funds, investment and technology. Ultimately, however, they would like to transform their economies and become consumer-led economies as only that increases domestic living standards.
Looking at The Economist’s Big Mac index, it becomes evident that it is mainly producer nations' currencies that are undervalued and consumer nations' currencies that are overvalued. Initially, the Asian economies were far too small of a market and their consumers lacked sufficient purchasing power, hence the currency gambit. Ironically enough, just as their citizens' purchasing power rises, by moving up the value chain their produced goods become more expensive as well.
It is here that current American monetary policy comes into play. For decades, the process of Asian ‘handing over' purchasing power worked by and large to the benefit of American consumers. By virtue of being born American, one was in the enviable position of being able to consume more than could be justified in pure economic terms. When the White House talks about pushing up the value of the Chinese yuan, it at the same time also makes the case for bringing this arrangement to an end.
What goes unappreciated is that if the Fed increases the money supply, say via Quantitative Easing, this forces nations such as China to restrict their own share of the world economy. Typically, if a country goes through inflation, the value of its currency goes down (law of one price). But the U.S. is protected from this because of the role of the dollar. QE drives the price of commodities higher in dollar terms (all else being equal), but Asian nations cannot afford to let the value of currencies rise in the same fashion to cushion that effect. Europe’s protected from that as the euro is allowed to make the necessary adjustments and American workers’ compensation increases in line with inflation. The direct consequence is that Asian citizens are losing out on the world market. If you make 2500RMB a month, but the price of oil rises without the RMB moving upwards, you lose real purchasing power. America has the privilege of being able to flood the world economy with dollars while being able to push the cost of adapting to producer nations. That creates a dangerous dis-equilibrium in that currencies such as the RMB move further and further away from their real value. Naturally, there are two sides to this issue. While Chinese anger about this is understandable, the free-market case for letting the currency appreciate is just as strong.
The difficulty of incorporating asset values and services into GDP is that they are basically leveraged plays on a country's core economic strength. The same task, e.g. serving burgers, adds more to GDP in developed than developing nations. Yet, if the country's core strength is miscalculated, the whole edifice suffers as a consequence. And this is where it gets phenomenally tricky. Some analysts disregard the importance of the Japanese export sector as it makes up only a small fraction of total GDP, yet it is from that exporting prowess that many other industries derive their prosperity.
China’s share of global private consumption is at a mere 5.6% compared with 29.1% for the US and 26.2% in Western Europe. Yet, at the same time, a China which isn’t even close to reaching its full potential is already the largest market for many consumer goods, including cars.
How would America’s share of global consumption look if other nations stopped undervaluing their currencies? What about commodity prices? Which countries could benefit from a proper adjustment? China is an easy answer, yet its export industries rely on the currency subsidy. In order to answer that question accurately, one would need much more data and a whole array of tools, but it is not far-fetched to assume that the global market share of America would fall substantially. Economies are complex systems and there’s never only one side to any given story.
As I noted in an earlier article, an undervalued RMB causes problems for the lower class in America and Europe via increased competition for low-skilled jobs, but a more market-based RMB would create problems for the middle and upper class via lowering their global purchasing power and higher commodity prices.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.