Imagine how Americans would feel if we suddenly realized that our most trusted trade partners have been slowly but inexorably imposing a tariff against U.S. goods since 2002a tariff now in excess of 50%.
What really stings is that these same trade partners are also our most important allies, in both military and ideological terms. We like to think we share the same moral values when it comes to defending democracy and the virtues of free market capitalism.
How disillusioning to discover that the leading proponents of open global tradethe ones who insist on a level playing fieldthink nothing of adopting policies that render our products overly expensive for their consumers, even as they proffer their goods around the world at inordinately discounted prices.
Now you know how members of the European Union feel these days.
As former New York Fed economist David King recently observed, the value of the U.S. dollar against the euro has fallen drastically in the last few years. In December 2002, one dollar was equal in value to one euro; today, it requires more than half again as many dollars to equal one euro. For American consumers, that means prices of imported European goods are more than half again higher than they would be had the dollar retained its value relative to the euro.
Too bad for our esteemed friends across the Atlantic. If the steep price rise was the result of a tariff imposed by the U.S. government, they could haul us before the World Trade Organization on a complaint that we engage in unfair trade practices. But since its accomplished through loose monetary policy for domestic purposes and bolstered by plausible deniability at the highest levelsA strong dollar is in our nations interestthere is little the Europeans can do about it.
The euro is the official currency used by 320 million Europeans in 15 member states: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia and Spain. Another three member statesDenmark, Sweden and the United Kingdomuse their own currencies. But the nine countries that have become EU member states since 2004 have all set convergence goals to join the eurozone in the near future: Slovakia (2009), Lithuania (2010), Estonia (2011), Bulgaria (2012), Hungary (2012), Latvia (2012), Czech Republic (2012), Poland (2012) and Romania (2012).
Taking note of these latest EU member statesformer victims of Soviet-style central planning, now advocates for private enterprisemakes it clear that the U.S. has much more at stake than merely undercutting the competition in global markets with cheapened dollars. The connection between price stability and entrepreneurial effort is profound. Why should anyone work hard or take risks if financial rewards can be blithely confiscated through inflation? The old communist aphorismThey pretend to pay us and we pretend to workreflects deep cynicism borne of citizen subservience to totalitarian government. Honest money is the bedrock of democratic capitalism.
When the U.S. turns a blind eye to the consequences of diluting the value of its monetary unit, when we abuse the privilege of supplying the global reserve currency by resorting to sleight-of-hand monetary policy to address our own economic problemsinflating our way out of the housing crisis, pushing taxpayers into higher brackets through stealthit sends a disturbing message to the world.
Why would the nation that espouses Adam Smith and the wisdom of the invisible hand permit its currency to confound the validity of price signals in the global marketplace? How can Americans champion the cause of free trade and exhort other nations to rid themselves of protectionist measures such as tariffs and subsidiesand then smugly claim that U.S. exports are becoming more competitive as the dollar sinks?
Thats not competing. Its cheating.
The U.S. cannot go on pretending the dollars fate is somehow beyond our ken. Maintaining a reliable currency is a moral responsibility as well as a strategic imperative. To the extent we force Europeans to bear the costs of fighting inflation unleashed by accommodative Fed policyhigher interest rates and the hidden tariff of currency appreciationwe renege on our shared commitment to democratic capitalism, both in principle and practice. Moreover, we risk causing a rift in our vital alliance at a time when the geopolitical situation most requires strategic partnership.
It is interesting that one of the major foreign policy goals envisioned by Republican presidential candidate John McCain is to form a League of Democracies to promote the values of freedom and democracy. I am an idealist, Sen. McCain noted in remarks before the Los Angeles World Affairs Council this past March, and I believe it is possible in our time to make the world we live in another, better, more peaceful place, where our interests and those of our allies are more secure, and American ideals that are transforming the world, the principles of free people and free markets, advance even farther than they have.
The greatest ideological struggle since World War IIthe one with the potential to devastate mankind through a nuclear exchangeunited the U.S. and what was then called Western Europe against an Eastern bloc dominated by the Soviet Union. As todays Russia displays renewed interest in recapturing old territory, the seeming Cold War victory of democratic capitalism cannot be taken for granted. Nor should we underestimate the role of stable international monetary relations to facilitate free markets and secure the blessings of free trade.
Ukraine is among the most besiegedand perhaps the most pivotalof Europes recent converts to democracy. The biggest threat to Ukraines prospects for success, both politically and economically? Inflation, now soaring past 30%. Ukraines hryvnia is pegged to the dollar; every cut in the U.S. fed-funds rate spawns huge dollar inflows that must be converted by Ukraines central bank into the domestic currency, further exacerbating inflation.
One way to mitigate the impact would be to let the hryvnia appreciate relative to the dollar. But that would doom Ukraines efforts to boost its two main exporting industries, metallurgy and chemicals. Ironically, Russia finds itself in a similar monetary predicament, forced to choose between inflation (the ruble is based 55% on the dollar, 45% on the euro) or a rising currency.
Its hard to elicit sympathy for oil-rich Russia right now. Still, the economic uncertainties and social tensions unleashed by currency chaos can only damage the outlook for democratic states across Europe and the world. Mr. McCains proposal for creating new institutions to secure and advance the transforming values of individual liberty and entrepreneurial capitalism holds out great promise. But to provide a stable foundation for global prosperity, the League of Democracies also needs to take on the essential task of international monetary reform.
Edouard Balladur, Frances former prime minister, called for a union between Europe and the U.S. in a 120-page essay published in France last November, asserting it is time to put an end to the disorder of floating currencies, which threatens the prosperity of the world and its progress, and which, in the end will destroy the very idea of liberalism. Nobel laureate Robert Mundell suggests a multiple-currency monetary union among the dollar, euro and yen that could be patterned similarly to the process that brought about European monetary union. Both men have invoked the possible inclusion of gold in a reformed international monetary system, recognizing the importance of protecting its integrity through automatic mechanisms and sanctions beyond the control of governments.
Notwithstanding Fed Chairman Ben Bernankes assurancesWe are attentive to the implications of changes in the value of the dollar for inflationthe need for honest money remains.
A gold standard beats a gab standard.