Sunday, 22 May 2011

Why do we subsidise imports?

Image: Keattikorn /
One of the elements of monetary policy that has me constantly perplexed is why countries maintain a positive policy interest rate at all.

I appreciate (although don't agree with) the inflation targeting idea, but I just don't see why you would pay people not to spend, when you have the power to stop people spending via taxation.

Interest rate manipulation merely moves money from borrowers to savers and vice versa - possibly with perverse results.

So the real effect seems to rely on the amount of government spending that is directed into the private sector via the interest rate channel, and the supposed effect that has on the exchange rate and investment rates. All of which have the same level of evidence for their effectiveness as tea-leaf reading as far as I can see.

So you have the almost unbelievable situation (using the UK as an example) of the UK government rewarding foreigners who avoid spending their Sterling with UK businesses.

With that set up it's hardly surprising that allegedly 95% of currency exchanges are for speculative purposes and only 5% for actual trade.

Now one of the alleged effects of a higher interest rate is that the currency is 'stronger' compared to its peers. But if it is stronger it is only stronger as the result of speculation, not fundamental demand for the country's goods and services. It's a false notion.

'Stronger' currencies can buy more goods and service from overseas, and so tying the two ends together you end up with the government paying foreigners more currency so that the country can import more goods and services.

With current budget balancing policies it seems to me that means taxing the citizens of your country so that you can subsidise imports and close down substitute domestic production. That's crazy isn't it?

Isn't it time to get off the drug of artificially inflated currencies and get back to good old fashioned trading?