“Inflation is a tax on money, wealth creation, income, and work effort. Inflation is a devastating tax on savings. But low inflation is a tax cut. By enhancing the value of financial assets, price stability rewards patient savers and investors. It is a stimulant to capital formation, new business start-ups and growth. Growth does not cause inflation, low inflation causes growth."
-- Lawrence Kudlow, American Abundance
The above passage comes from Larry Kudlow’s 1996 book, American Abundance. He was writing about the Bill Clinton economy. Kudlow plainly didn’t agree with Clinton on everything, particularly when it came to taxation of income, but he cheered the Clinton administration’s oversight of the dollar.
While facile minds have reduced the dollar’s exchange movements in modern times to the doings of the Federal Reserve, Kudlow knew the truth: presidential administrations broadly get the dollar they want. And since they do, he cheered President Clinton’s Treasury Secretary, Robert Rubin. Rubin routinely made plain his preference for a strong dollar, and markets complied.
As a consequence of Rubin’s actions, Kudlow knew well the source of the economic boom under Clinton: economic growth is an effect of investment, and a strong dollar removed the certain tax on investment that is a falling dollar. Let’s never forget that investment is the process whereby those who have access to resources direct them to higher uses with an eye on attaining more resources down the line. When an investor directs for instance $1 million dollars to an existing business, or a start-up, that investor is shifting resource access (think computers, office space, labor, etc.) to the business with an eye on attaining even greater resource access (what’s referred to as an investment return) in the future.
Just as trade is always and everywhere about products for products with money as the measure facilitating the exchange, so is investment. Investment is merely a delayed accession of products and services (once again computers, office space, labor, airplane flights, hotel rooms, meals, etc.) based on an initial shift of those products and services to others. “Money” isn’t wealth as much as it’s an agreement about value that simplifies the movement of real goods and services from one set of hands to another.
Crucial from an investment perspective is that investors don’t want to shift resources to a higher use (investment) only to get a return years later that commands fewer resources. This speaks to the horror of dollar devaluation, and why the latter usually correlates with slow economic growth. If investment is the driver of economic growth, and it is, currency devaluation is a logical barrier to growth for it existing as a tax on investment. Reducing what’s basic to what is basic, why invest if any returns will come back in dollars that command fewer goods and services?
Which brings us to recent Tweets by President Trump about China. Trump contends that China has “used currency manipulation to steal our businesses and factories, hurt our jobs, depress our workers’ wages and harm our farmers’ prices.” Up front, such a charge is absurd. It’s the equivalent of Los Angeles Lakers center Anthony Davis explaining a 6’ guard dunking on him as an effect of the guard cutting the length of the inch in half in order to be 12 feet tall. Useful here is that neither Davis nor anyone with two passably working eyes would fall for the shrinking of the inch. It wouldn’t alter reality. The guard would still be 6 feet tall in a real sense. Money is no different. Changes in its value can’t rewrite reality.
In that case, currency devaluation doesn’t render a country or business more economically competitive. Quite the opposite, really. So while China’s yuan has in fact risen against the dollar since 2005, if it had been falling for years as Trump falsely attests, the latter would in no way have enhanced Chinese competitiveness. The reasons why should be obvious. A shrunken yuan would mean that labor and inputs in order to create goods and services would increase in price to reflect the fact that a yuan is suddenly exchangeable for less. There’s quite simply no hiding from devaluation. If you shrink the currency, you raise your costs in that currency. And the story gets worse.
As previously stated, no one invests dollars, yuan, euros, pounds, or anything else. Money is just an agreement about value that allows us to shift resources (investment) toward others with an eye on accession of more in the way of resources in the future. But if the currency is in decline, the shift of resources to higher uses that investment signifies is less likely to happen. Why once again delay the exchange of dollars for real goods and services if dollars invested come back years later in shrunken fashion? Businesses need resources to grow, the latter is a statement of the obvious, and devaluation makes the shifting of resources more costly.
This is one thing President Trump is plainly missing in his calls for a weaker dollar, and with his laments about an allegedly declining yuan. He’s communicating to markets his desire for a weaker dollar. And markets are complying. Kudlow surely knows this as gold is an objective measure of value that he’s long accepted as a worthy signal of the dollar’s health. While a dollar bought roughly 1/1200th of an ounce of gold when Trump entered office in 2017, it presently buys 1/1475th. The dollar is in decline, and with it, the tax on investment is rising.
None of the above is improved by the imposition of tariffs on Chinese producers by Trump. In making it more difficult for Americans to import Chinese plenty, the president has made it more difficult for the Chinese to buy American plenty. This matters when it’s remembered what a large – and rapidly growing – market China is for U.S. producers. U.S. stocks have long been priced to reflect a growing Chinese market for U.S. goods, yet Trump is trying to shrink it given a mistaken presumption that the Chinese economy can be weakened without shrinking the one in the U.S.
So there you go. While one day in the markets shouldn’t be construed as indicative of overall market health, stock markets are a signaling device about the future. Yesterday’s selloff presumably reflects investor worry about the dollar, and where Trump is taking his trade war. The dollar is rapidly falling, and as the Nixon, Carter and Bush presidencies should remind us, a falling currency always correlates with slow growth since devaluation is a tax. Tariffs limit the ability of the world’s best companies (that would be American companies) to sell around the world. Economics isn’t very complicated.
President Trump should realize this, or his advisers should help him to realize this. He’s wisely staked his presidency on a healthy economy and stock market. Good for him. Every president should. The problem is that tariffs and devaluation never correlate with a good economy, and by extension never boost stock markets.